Is Graphex Group (HKG:6128) Weighed On By Its Debt Load?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Graphex Group Limited (HKG:6128) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Graphex Group

How Much Debt Does Graphex Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Graphex Group had HK$551.9m of debt, an increase on HK$514.3m, over one year. On the flip side, it has HK$28.4m in cash leading to net debt of about HK$523.5m.

How Healthy Is Graphex Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Graphex Group had liabilities of HK$290.4m due within 12 months and liabilities of HK$654.7m due beyond that. Offsetting this, it had HK$28.4m in cash and HK$159.0m in receivables that were due within 12 months. So its liabilities total HK$757.6m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$376.0m 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 definitely think shareholders need to watch this one closely. After all, Graphex Group 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 Graphex Group's earnings that will influence how the balance sheet holds up in the future. 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, Graphex Group reported revenue of HK$416m, which is a gain of 10%, 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, Graphex Group had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$61m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$5.9m in negative free cash flow over the last year. So suffice it to say 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. We've identified 5 warning signs with Graphex Group (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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.

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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