Is Changsha Broad Homes Industrial Group (HKG:2163) Using Debt In A Risky Way?

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. As with many other companies Changsha Broad Homes Industrial Group Co., Ltd. (HKG:2163) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Changsha Broad Homes Industrial Group

What Is Changsha Broad Homes Industrial Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Changsha Broad Homes Industrial Group had debt of CN¥3.18b, up from CN¥2.92b in one year. However, it does have CN¥347.2m in cash offsetting this, leading to net debt of about CN¥2.83b.

How Healthy Is Changsha Broad Homes Industrial Group's Balance Sheet?

We can see from the most recent balance sheet that Changsha Broad Homes Industrial Group had liabilities of CN¥3.96b falling due within a year, and liabilities of CN¥1.77b due beyond that. Offsetting these obligations, it had cash of CN¥347.2m as well as receivables valued at CN¥2.65b due within 12 months. So it has liabilities totalling CN¥2.73b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥2.52b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Changsha Broad Homes Industrial Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Changsha Broad Homes Industrial Group had a loss before interest and tax, and actually shrunk its revenue by 5.2%, to CN¥2.7b. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Changsha Broad Homes Industrial Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥113m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of CN¥342m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. For instance, we've identified 1 warning sign for Changsha Broad Homes Industrial Group that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.