Is Neo-Neon Holdings (HKG:1868) 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.' 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. Importantly, Neo-Neon Holdings Limited (HKG:1868) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

View our latest analysis for Neo-Neon Holdings

What Is Neo-Neon Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Neo-Neon Holdings had CN¥345.7m of debt in December 2020, down from CN¥494.8m, one year before. But on the other hand it also has CN¥451.7m in cash, leading to a CN¥106.0m net cash position.

How Healthy Is Neo-Neon Holdings' Balance Sheet?

We can see from the most recent balance sheet that Neo-Neon Holdings had liabilities of CN¥288.2m falling due within a year, and liabilities of CN¥289.8m due beyond that. On the other hand, it had cash of CN¥451.7m and CN¥287.7m worth of receivables due within a year. So it can boast CN¥161.5m more liquid assets than total liabilities.

This surplus suggests that Neo-Neon Holdings is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Neo-Neon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Neo-Neon Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Neo-Neon Holdings reported revenue of CN¥877m, which is a gain of 4.3%, 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.

So How Risky Is Neo-Neon Holdings?

Although Neo-Neon Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥169m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. For example, we've discovered 1 warning sign for Neo-Neon Holdings that you should be aware of before investing here.

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.

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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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