Is Jiahua Stores Holdings (HKG:602) Weighed On By Its Debt Load?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Jiahua Stores Holdings Limited (HKG:602) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

Check out our latest analysis for Jiahua Stores Holdings

How Much Debt Does Jiahua Stores Holdings Carry?

As you can see below, at the end of June 2022, Jiahua Stores Holdings had CN¥120.0m of debt, up from CN¥95.1m a year ago. Click the image for more detail. However, it does have CN¥31.2m in cash offsetting this, leading to net debt of about CN¥88.9m.

How Healthy Is Jiahua Stores Holdings' Balance Sheet?

We can see from the most recent balance sheet that Jiahua Stores Holdings had liabilities of CN¥231.7m falling due within a year, and liabilities of CN¥523.6m due beyond that. Offsetting these obligations, it had cash of CN¥31.2m as well as receivables valued at CN¥52.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥671.2m.

This deficit casts a shadow over the CN¥47.2m company, like a colossus towering over mere mortals. 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. There's no doubt that we learn most about debt from the balance sheet. 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.

In the last year Jiahua Stores Holdings had a loss before interest and tax, and actually shrunk its revenue by 21%, to CN¥356m. To be frank that doesn't bode well.

Caveat Emptor

While Jiahua Stores 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. Its EBIT loss was a whopping CN¥60m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. 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¥96m in the last year. So we're not very excited about owning this stock. Its too risky for us. 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. Be aware that Jiahua Stores Holdings is showing 3 warning signs in our investment analysis , you should know about...

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.