Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 China Fordoo Holdings Limited (HKG:2399) makes use of 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Fordoo Holdings's Debt?
The chart below, which you can click on for greater detail, shows that China Fordoo Holdings had CN¥510.1m in debt in December 2020; about the same as the year before. However, it also had CN¥196.7m in cash, and so its net debt is CN¥313.4m.
How Strong Is China Fordoo Holdings' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that China Fordoo Holdings had liabilities of CN¥592.6m due within 12 months and liabilities of CN¥69.9m due beyond that. On the other hand, it had cash of CN¥196.7m and CN¥163.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥302.7m.
Since publicly traded China Fordoo Holdings shares are worth a total of CN¥2.33b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 Fordoo 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.
In the last year China Fordoo Holdings had a loss before interest and tax, and actually shrunk its revenue by 25%, to CN¥270m. To be frank that doesn't bode well.
Not only did China Fordoo Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥147m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥290m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Fordoo Holdings is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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China Anchu Energy Storage Group
China Anchu Energy Storage Group Limited designs, sources, manufactures, and wholesales a range of menswear products under the FORDOO brand in the People’s Republic of China.
Mediocre balance sheet and overvalued.