Is Shengli Oil & Gas Pipe Holdings (HKG:1080) Using Debt In A Risky Way?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shengli Oil & Gas Pipe Holdings Limited (HKG:1080) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Shengli Oil & Gas Pipe Holdings

What Is Shengli Oil & Gas Pipe Holdings's Debt?

As you can see below, at the end of June 2021, Shengli Oil & Gas Pipe Holdings had CN¥749.6m of debt, up from CN¥712.6m a year ago. Click the image for more detail. However, it does have CN¥82.2m in cash offsetting this, leading to net debt of about CN¥667.4m.

How Strong Is Shengli Oil & Gas Pipe Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shengli Oil & Gas Pipe Holdings had liabilities of CN¥1.41b due within 12 months and liabilities of CN¥4.84m due beyond that. Offsetting these obligations, it had cash of CN¥82.2m as well as receivables valued at CN¥343.9m due within 12 months. So its liabilities total CN¥990.2m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥314.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Shengli Oil & Gas Pipe Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shengli Oil & Gas Pipe 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.

Over 12 months, Shengli Oil & Gas Pipe Holdings reported revenue of CN¥1.1b, which is a gain of 71%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Shengli Oil & Gas Pipe Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable CN¥149m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized CN¥37m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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. For example, we've discovered 3 warning signs for Shengli Oil & Gas Pipe Holdings that you should be aware of before investing here.

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.

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