Is ArtGo Holdings (HKG:3313) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, ArtGo Holdings Limited (HKG:3313) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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.

See our latest analysis for ArtGo Holdings

What Is ArtGo Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that ArtGo Holdings had CN¥309.3m of debt in June 2021, down from CN¥508.2m, one year before. However, it does have CN¥39.7m in cash offsetting this, leading to net debt of about CN¥269.6m.

How Healthy Is ArtGo Holdings' Balance Sheet?

According to the last reported balance sheet, ArtGo Holdings had liabilities of CN¥240.1m due within 12 months, and liabilities of CN¥328.1m due beyond 12 months. On the other hand, it had cash of CN¥39.7m and CN¥41.6m worth of receivables due within a year. So its liabilities total CN¥486.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥174.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, ArtGo Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is ArtGo 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.

In the last year ArtGo Holdings had a loss before interest and tax, and actually shrunk its revenue by 74%, to CN¥70m. That makes us nervous, to say the least.

Caveat Emptor

While ArtGo Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥66m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized CN¥18m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. Case in point: We've spotted 4 warning signs for ArtGo Holdings you should be aware of, and 1 of them is a bit unpleasant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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