Is Haichang Ocean Park Holdings (HKG:2255) Using Debt Sensibly?

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. Importantly, Haichang Ocean Park Holdings Ltd. (HKG:2255) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Haichang Ocean Park Holdings

What Is Haichang Ocean Park Holdings's Debt?

As you can see below, Haichang Ocean Park Holdings had CN¥8.83b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.75b in cash offsetting this, leading to net debt of about CN¥7.08b.

How Healthy Is Haichang Ocean Park Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Haichang Ocean Park Holdings had liabilities of CN¥5.03b due within 12 months and liabilities of CN¥7.63b due beyond that. Offsetting these obligations, it had cash of CN¥1.75b as well as receivables valued at CN¥235.5m due within 12 months. So it has liabilities totalling CN¥10.7b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥7.85b, we think shareholders really should watch Haichang Ocean Park Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Haichang Ocean Park Holdings will need earnings to service that debt. 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 Haichang Ocean Park Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 6.2%, to CN¥2.2b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Haichang Ocean Park Holdings produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥131m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of CN¥853m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Haichang Ocean Park Holdings (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.