The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, China Fordoo Holdings Limited (HKG:2399) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is China Fordoo Holdings's Debt?
As you can see below, China Fordoo Holdings had CN¥464.6m of debt at June 2021, down from CN¥518.3m a year prior. However, because it has a cash reserve of CN¥109.3m, its net debt is less, at about CN¥355.3m.
How Strong Is China Fordoo Holdings' Balance Sheet?
According to the last reported balance sheet, China Fordoo Holdings had liabilities of CN¥572.2m due within 12 months, and liabilities of CN¥68.6m due beyond 12 months. Offsetting this, it had CN¥109.3m in cash and CN¥231.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥300.3m.
China Fordoo Holdings has a market capitalization of CN¥1.12b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Fordoo Holdings's earnings that will influence how the balance sheet holds up in the future. 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, China Fordoo Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥281m, which is a fall of 10%. That's not what we would hope to see.
While China Fordoo Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥142m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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. For instance, we've identified 3 warning signs for China Fordoo Holdings (2 are concerning) 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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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.