Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, China Partytime Culture Holdings Limited (HKG:1532) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.
How Much Debt Does China Partytime Culture Holdings Carry?
The image below, which you can click on for greater detail, shows that China Partytime Culture Holdings had debt of CN¥81.5m at the end of June 2021, a reduction from CN¥113.7m over a year. But it also has CN¥84.6m in cash to offset that, meaning it has CN¥3.15m net cash.
How Healthy Is China Partytime Culture Holdings' Balance Sheet?
According to the last reported balance sheet, China Partytime Culture Holdings had liabilities of CN¥113.7m due within 12 months, and liabilities of CN¥5.64m due beyond 12 months. Offsetting these obligations, it had cash of CN¥84.6m as well as receivables valued at CN¥70.0m due within 12 months. So it actually has CN¥35.4m more liquid assets than total liabilities.
This excess liquidity suggests that China Partytime Culture Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, China Partytime Culture Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Partytime Culture Holdings will need earnings to service that debt. 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, China Partytime Culture Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥240m, which is a fall of 11%. That's not what we would hope to see.
So How Risky Is China Partytime Culture Holdings?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months China Partytime Culture Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥22m and booked a CN¥30m accounting loss. But the saving grace is the CN¥3.15m on the balance sheet. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for China Partytime Culture Holdings you should be aware of, and 1 of them is concerning.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you're looking for stocks to buy, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.