Is China Demeter Financial Investments (HKG:8120) Using Debt Sensibly?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that China Demeter Financial Investments Limited (HKG:8120) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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.

View our latest analysis for China Demeter Financial Investments

What Is China Demeter Financial Investments's Debt?

As you can see below, at the end of December 2021, China Demeter Financial Investments had HK$20.1m of debt, up from HK$10.0m a year ago. Click the image for more detail. But it also has HK$75.6m in cash to offset that, meaning it has HK$55.5m net cash.

A Look At China Demeter Financial Investments' Liabilities

According to the last reported balance sheet, China Demeter Financial Investments had liabilities of HK$109.2m due within 12 months, and liabilities of HK$13.5m due beyond 12 months. Offsetting these obligations, it had cash of HK$75.6m as well as receivables valued at HK$17.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$29.8m.

While this might seem like a lot, it is not so bad since China Demeter Financial Investments has a market capitalization of HK$82.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, China Demeter Financial Investments also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since China Demeter Financial Investments 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.

In the last year China Demeter Financial Investments wasn't profitable at an EBIT level, but managed to grow its revenue by 30%, to HK$177m. With any luck the company will be able to grow its way to profitability.

So How Risky Is China Demeter Financial Investments?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that China Demeter Financial Investments had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$24m and booked a HK$21m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of HK$55.5m. That means it could keep spending at its current rate for more than two years. With very solid revenue growth in the last year, China Demeter Financial Investments may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. 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 instance, we've identified 2 warning signs for China Demeter Financial Investments (1 can't be ignored) you should be aware of.

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.

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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.