Warren Buffett famously said, '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 Overseas Nuoxin International Holdings Limited (HKG:464) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Overseas Nuoxin International Holdings's Debt?
The chart below, which you can click on for greater detail, shows that China Overseas Nuoxin International Holdings had HK$91.7m in debt in September 2021; about the same as the year before. However, it also had HK$51.7m in cash, and so its net debt is HK$40.0m.
A Look At China Overseas Nuoxin International Holdings' Liabilities
Zooming in on the latest balance sheet data, we can see that China Overseas Nuoxin International Holdings had liabilities of HK$194.4m due within 12 months and liabilities of HK$17.5m due beyond that. On the other hand, it had cash of HK$51.7m and HK$65.6m worth of receivables due within a year. So its liabilities total HK$94.6m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since China Overseas Nuoxin International Holdings has a market capitalization of HK$211.7m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China Overseas Nuoxin International 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 China Overseas Nuoxin International Holdings had a loss before interest and tax, and actually shrunk its revenue by 19%, to HK$320m. That's not what we would hope to see.
While China Overseas Nuoxin International 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. Indeed, it lost a very considerable HK$27m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of HK$35m. So we do think this stock is quite risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Overseas Nuoxin International Holdings (of which 1 is a bit concerning!) you should know about.
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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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.