Is China Dongxiang (Group) (HKG:3818) Using Debt In A Risky Way?

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 China Dongxiang (Group) Co., Ltd. (HKG:3818) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for China Dongxiang (Group)

What Is China Dongxiang (Group)'s Net Debt?

The image below, which you can click on for greater detail, shows that China Dongxiang (Group) had debt of CN¥41.1m at the end of September 2022, a reduction from CN¥70.4m over a year. However, it does have CN¥3.90b in cash offsetting this, leading to net cash of CN¥3.85b.

How Strong Is China Dongxiang (Group)'s Balance Sheet?

The latest balance sheet data shows that China Dongxiang (Group) had liabilities of CN¥676.7m due within a year, and liabilities of CN¥326.0m falling due after that. On the other hand, it had cash of CN¥3.90b and CN¥486.2m worth of receivables due within a year. So it can boast CN¥3.38b more liquid assets than total liabilities.

This excess liquidity is a great indication that China Dongxiang (Group)'s balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, China Dongxiang (Group) 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 it is future earnings, more than anything, that will determine China Dongxiang (Group)'s ability to maintain a healthy balance sheet going forward. 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, China Dongxiang (Group) made a loss at the EBIT level, and saw its revenue drop to CN¥1.8b, which is a fall of 8.3%. That's not what we would hope to see.

So How Risky Is China Dongxiang (Group)?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year China Dongxiang (Group) had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥80m and booked a CN¥1.4b accounting loss. Given it only has net cash of CN¥3.85b, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. For riskier companies like China Dongxiang (Group) I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.