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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Dongfeng Motor Group Company Limited (HKG:489) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out the opportunities and risks within the HK Auto industry.

What Is Dongfeng Motor Group's Debt?

As you can see below, Dongfeng Motor Group had CN¥53.1b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥84.1b in cash, so it actually has CN¥31.0b net cash.

A Look At Dongfeng Motor Group's Liabilities

The latest balance sheet data shows that Dongfeng Motor Group had liabilities of CN¥125.0b due within a year, and liabilities of CN¥30.2b falling due after that. Offsetting this, it had CN¥84.1b in cash and CN¥17.8b in receivables that were due within 12 months. So it has liabilities totalling CN¥53.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥32.5b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Dongfeng Motor Group would probably need a major re-capitalization if its creditors were to demand repayment. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Dongfeng Motor Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Dongfeng Motor Group had a loss before interest and tax, and actually shrunk its revenue by 32%, to CN¥87b. To be frank that doesn't bode well.

So How Risky Is Dongfeng Motor Group?

While Dongfeng Motor Group lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥8.3b. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Dongfeng Motor Group is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.