Is Jiu Rong Holdings (HKG:2358) Using Debt In A Risky Way?

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.' 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 Jiu Rong Holdings Limited (HKG:2358) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Jiu Rong Holdings

What Is Jiu Rong Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Jiu Rong Holdings had HK$713.9m in debt in June 2023; about the same as the year before. However, it also had HK$19.5m in cash, and so its net debt is HK$694.3m.

How Healthy Is Jiu Rong Holdings' Balance Sheet?

We can see from the most recent balance sheet that Jiu Rong Holdings had liabilities of HK$1.45b falling due within a year, and liabilities of HK$665.8m due beyond that. Offsetting these obligations, it had cash of HK$19.5m as well as receivables valued at HK$526.3m due within 12 months. So its liabilities total HK$1.57b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$191.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Jiu Rong Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Jiu Rong Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Jiu Rong Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 16%, to HK$791m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Jiu Rong Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$70m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through HK$45m in the last year. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Jiu Rong Holdings has 4 warning signs (and 3 which are concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.