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.' 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 Jiahua Stores Holdings Limited (HKG:602) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Jiahua Stores Holdings

What Is Jiahua Stores Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2021 Jiahua Stores Holdings had CN¥93.4m of debt, an increase on CN¥66.9m, over one year. However, it does have CN¥26.1m in cash offsetting this, leading to net debt of about CN¥67.3m.

A Look At Jiahua Stores Holdings' Liabilities

According to the last reported balance sheet, Jiahua Stores Holdings had liabilities of CN¥258.9m due within 12 months, and liabilities of CN¥527.2m due beyond 12 months. On the other hand, it had cash of CN¥26.1m and CN¥53.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥706.9m.

This deficit casts a shadow over the CN¥52.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Jiahua Stores Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Jiahua Stores Holdings saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

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¥54m 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 lost CN¥100m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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 example, we've discovered 3 warning signs for Jiahua Stores Holdings (2 are significant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.