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.' 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. Importantly, China Shun Ke Long Holdings Limited (HKG:974) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does China Shun Ke Long Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that China Shun Ke Long Holdings had CN¥60.0m of debt in December 2021, down from CN¥108.0m, one year before. However, it does have CN¥103.3m in cash offsetting this, leading to net cash of CN¥43.3m.
How Healthy Is China Shun Ke Long Holdings' Balance Sheet?
According to the last reported balance sheet, China Shun Ke Long Holdings had liabilities of CN¥224.7m due within 12 months, and liabilities of CN¥56.0m due beyond 12 months. Offsetting this, it had CN¥103.3m in cash and CN¥82.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥95.1m.
This deficit isn't so bad because China Shun Ke Long Holdings is worth CN¥164.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, China Shun Ke Long 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 Shun Ke Long 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.
Over 12 months, China Shun Ke Long Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥742m, which is a fall of 17%. That's not what we would hope to see.
So How Risky Is China Shun Ke Long Holdings?
Although China Shun Ke Long Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥48m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for China Shun Ke Long Holdings (of which 1 is a bit unpleasant!) 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.
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.