Is Jiahua Stores Holdings (HKG:602) 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Jiahua Stores Holdings Limited (HKG:602) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Jiahua Stores Holdings

What Is Jiahua Stores Holdings's Debt?

As you can see below, at the end of June 2021, Jiahua Stores Holdings had CN¥95.1m of debt, up from none a year ago. Click the image for more detail. On the flip side, it has CN¥67.7m in cash leading to net debt of about CN¥27.3m.

How Strong Is Jiahua Stores Holdings' Balance Sheet?

According to the last reported balance sheet, Jiahua Stores Holdings had liabilities of CN¥260.7m due within 12 months, and liabilities of CN¥557.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥67.7m as well as receivables valued at CN¥63.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥687.0m.

The deficiency here weighs heavily on the CN¥111.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Jiahua Stores Holdings would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiahua Stores 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.

In the last year Jiahua Stores Holdings had a loss before interest and tax, and actually shrunk its revenue by 8.7%, to CN¥450m. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Jiahua Stores Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥19m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it burned through CN¥2.6m in the last year. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. When analysing debt levels, the balance sheet is the obvious place to start. 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 3 warning signs for Jiahua Stores Holdings (of which 1 shouldn't be ignored!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.
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