Health Check: How Prudently Does Shanshan Brand Management (HKG:1749) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Shanshan Brand Management Co., Ltd. (HKG:1749) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanshan Brand Management

What Is Shanshan Brand Management's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shanshan Brand Management had CN¥202.2m of debt in December 2020, down from CN¥280.0m, one year before. However, it does have CN¥111.3m in cash offsetting this, leading to net debt of about CN¥90.9m.

How Healthy Is Shanshan Brand Management's Balance Sheet?

According to the last reported balance sheet, Shanshan Brand Management had liabilities of CN¥658.4m due within 12 months, and liabilities of CN¥23.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥111.3m as well as receivables valued at CN¥163.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥406.7m.

This deficit casts a shadow over the CN¥55.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Shanshan Brand Management would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shanshan Brand Management 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, Shanshan Brand Management made a loss at the EBIT level, and saw its revenue drop to CN¥900m, which is a fall of 13%. That's not what we would hope to see.

Caveat Emptor

Not only did Shanshan Brand Management's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥78m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the fact is that it incinerated CN¥21m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. 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. For example - Shanshan Brand Management has 3 warning signs we think you should be aware of.

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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