Is Cosmo Lady (China) Holdings (HKG:2298) A Risky Investment?

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.' 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 Cosmo Lady (China) Holdings Company Limited (HKG:2298) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Cosmo Lady (China) Holdings

What Is Cosmo Lady (China) Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Cosmo Lady (China) Holdings had CN¥369.1m of debt in December 2021, down from CN¥537.8m, one year before. But it also has CN¥1.37b in cash to offset that, meaning it has CN¥999.2m net cash.

A Look At Cosmo Lady (China) Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Cosmo Lady (China) Holdings had liabilities of CN¥1.95b due within 12 months and liabilities of CN¥200.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.37b as well as receivables valued at CN¥280.6m due within 12 months. So its liabilities total CN¥502.8m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥668.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Cosmo Lady (China) 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 ultimately the future profitability of the business will decide if Cosmo Lady (China) Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Cosmo Lady (China) Holdings reported revenue of CN¥3.4b, which is a gain of 9.7%, 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.

So How Risky Is Cosmo Lady (China) Holdings?

Although Cosmo Lady (China) Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥58m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Cosmo Lady (China) Holdings (1 makes us a bit uncomfortable) you should be aware of.

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.

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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.