Health Check: How Prudently Does Graphex Group (HKG:6128) Use Debt?

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 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 can see that Graphex Group Limited (HKG:6128) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Graphex Group

What Is Graphex Group's Debt?

As you can see below, Graphex Group had HK$213.6m of debt at December 2023, down from HK$285.0m a year prior. However, it also had HK$27.2m in cash, and so its net debt is HK$186.4m.

How Strong Is Graphex Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Graphex Group had liabilities of HK$320.2m due within 12 months and liabilities of HK$157.5m due beyond that. Offsetting these obligations, it had cash of HK$27.2m as well as receivables valued at HK$177.9m due within 12 months. So it has liabilities totalling HK$272.6m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$137.5m 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. After all, Graphex Group would likely require a major re-capitalisation if it had to pay its creditors today. 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 Graphex Group's ability to maintain a healthy balance sheet going forward. 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 Graphex Group had a loss before interest and tax, and actually shrunk its revenue by 14%, to HK$292m. That's not what we would hope to see.

Caveat Emptor

While Graphex Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$92m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of HK$113m. In the meantime, we consider the stock to be risky. 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. To that end, you should learn about the 4 warning signs we've spotted with Graphex Group (including 1 which is a bit concerning) .

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.

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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.