Is China Wantian Holdings (HKG:1854) Using Debt In A Risky Way?

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.' 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. As with many other companies China Wantian Holdings Limited (HKG:1854) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Our analysis indicates that 1854 is potentially overvalued!

What Is China Wantian Holdings's Net Debt?

As you can see below, China Wantian Holdings had HK$15.0m of debt at September 2022, down from HK$40.7m a year prior. However, it does have HK$35.3m in cash offsetting this, leading to net cash of HK$20.2m.

A Look At China Wantian Holdings' Liabilities

According to the last reported balance sheet, China Wantian Holdings had liabilities of HK$21.6m due within 12 months, and liabilities of HK$5.80m due beyond 12 months. Offsetting these obligations, it had cash of HK$35.3m as well as receivables valued at HK$30.4m due within 12 months. So it actually has HK$38.2m more liquid assets than total liabilities.

This short term liquidity is a sign that China Wantian Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, China Wantian Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Wantian Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China Wantian Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 6.2%, to HK$128m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is China Wantian Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months China Wantian Holdings lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of HK$9.7m and booked a HK$18m accounting loss. Given it only has net cash of HK$20.2m, 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with China Wantian Holdings , and understanding them should be part of your investment process.

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.