Is Dongfeng Motor Group (HKG:489) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Dongfeng Motor Group Company Limited (HKG:489) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Dongfeng Motor Group

What Is Dongfeng Motor Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Dongfeng Motor Group had CN¥52.0b of debt in June 2021, down from CN¥59.1b, one year before. But it also has CN¥64.2b in cash to offset that, meaning it has CN¥12.1b net cash.

How Strong Is Dongfeng Motor Group's Balance Sheet?

The latest balance sheet data shows that Dongfeng Motor Group had liabilities of CN¥141.7b due within a year, and liabilities of CN¥28.9b falling due after that. Offsetting this, it had CN¥64.2b in cash and CN¥18.3b in receivables that were due within 12 months. So it has liabilities totalling CN¥88.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥52.7b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Dongfeng Motor Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that Dongfeng Motor Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

It was also good to see that despite losing money on the EBIT line last year, Dongfeng Motor Group turned things around in the last 12 months, delivering and EBIT of CN¥165m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dongfeng Motor Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Dongfeng Motor Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last year, Dongfeng Motor Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Dongfeng Motor Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥12.1b. Despite its cash we think that Dongfeng Motor Group seems to struggle to handle its total liabilities, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Dongfeng Motor Group you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.