Is Cosmo Lady (China) Holdings (HKG:2298) Using Debt Sensibly?

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.' 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 Cosmo Lady (China) Holdings Company Limited (HKG:2298) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Cosmo Lady (China) Holdings

How Much Debt Does Cosmo Lady (China) Holdings Carry?

As you can see below, Cosmo Lady (China) Holdings had CN¥477.5m of debt at June 2021, down from CN¥548.8m a year prior. But it also has CN¥1.30b in cash to offset that, meaning it has CN¥827.1m net cash.

How Strong Is Cosmo Lady (China) Holdings' Balance Sheet?

We can see from the most recent balance sheet that Cosmo Lady (China) Holdings had liabilities of CN¥1.89b falling due within a year, and liabilities of CN¥241.3m due beyond that. On the other hand, it had cash of CN¥1.30b and CN¥524.9m worth of receivables due within a year. So its liabilities total CN¥299.8m more than the combination of its cash and short-term receivables.

Cosmo Lady (China) Holdings has a market capitalization of CN¥1.30b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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¥3.6b, which is a gain of 11%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Cosmo Lady (China) Holdings?

While Cosmo Lady (China) Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥28m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Cosmo Lady (China) Holdings , 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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