Does Neo-Neon Holdings (HKG:1868) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Neo-Neon Holdings Limited (HKG:1868) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Neo-Neon Holdings

What Is Neo-Neon Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Neo-Neon Holdings had CN¥536.0m of debt in June 2020, down from CN¥566.3m, one year before. However, it does have CN¥477.9m in cash offsetting this, leading to net debt of about CN¥58.1m.

How Healthy Is Neo-Neon Holdings's Balance Sheet?

We can see from the most recent balance sheet that Neo-Neon Holdings had liabilities of CN¥374.5m falling due within a year, and liabilities of CN¥453.6m due beyond that. Offsetting these obligations, it had cash of CN¥477.9m as well as receivables valued at CN¥289.0m due within 12 months. So it has liabilities totalling CN¥61.2m more than its cash and near-term receivables, combined.

Given Neo-Neon Holdings has a market capitalization of CN¥884.5m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Neo-Neon Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Neo-Neon Holdings reported revenue of CN¥772m, which is a gain of 5.0%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Neo-Neon Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥83m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of CN¥128m. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Neo-Neon Holdings (of which 1 makes us a bit uncomfortable!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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