Is China Ecotourism Group (HKG:1371) A Risky Investment?

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 Ecotourism Group Limited (HKG:1371) does carry 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. If things get really bad, the lenders can take control of the business. 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. 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 China Ecotourism Group

What Is China Ecotourism Group's Debt?

You can click the graphic below for the historical numbers, but it shows that China Ecotourism Group had HK$324.1m of debt in December 2021, down from HK$426.6m, one year before. However, it also had HK$101.0m in cash, and so its net debt is HK$223.0m.

A Look At China Ecotourism Group's Liabilities

We can see from the most recent balance sheet that China Ecotourism Group had liabilities of HK$457.5m falling due within a year, and liabilities of HK$46.0m due beyond that. Offsetting this, it had HK$101.0m in cash and HK$13.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$389.2m.

This deficit casts a shadow over the HK$216.2m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Ecotourism Group would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Ecotourism Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, China Ecotourism Group saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Over the last twelve months China Ecotourism Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$154m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of HK$256m. And until that time we think this is a risky stock. 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. To that end, you should learn about the 4 warning signs we've spotted with China Ecotourism Group (including 2 which are a bit concerning) .

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.