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

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. Importantly, Graphex Group Limited (HKG:6128) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Graphex Group

What Is Graphex Group's Debt?

As you can see below, Graphex Group had HK$242.5m of debt at June 2023, down from HK$322.0m a year prior. However, it also had HK$17.5m in cash, and so its net debt is HK$225.0m.

A Look At Graphex Group's Liabilities

We can see from the most recent balance sheet that Graphex Group had liabilities of HK$257.0m falling due within a year, and liabilities of HK$280.7m due beyond that. Offsetting this, it had HK$17.5m in cash and HK$208.6m in receivables that were due within 12 months. So its liabilities total HK$311.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of HK$323.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Graphex Group'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 Graphex Group had a loss before interest and tax, and actually shrunk its revenue by 11%, to HK$329m. 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$55m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$54m. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Graphex Group is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.