Health Check: How Prudently Does Nine Dragons Paper (Holdings) (HKG:2689) Use Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Nine Dragons Paper (Holdings) Limited (HKG:2689) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 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.

View our latest analysis for Nine Dragons Paper (Holdings)

How Much Debt Does Nine Dragons Paper (Holdings) Carry?

The image below, which you can click on for greater detail, shows that at December 2022 Nine Dragons Paper (Holdings) had debt of CN¥51.2b, up from CN¥34.7b in one year. However, it also had CN¥8.39b in cash, and so its net debt is CN¥42.9b.

How Healthy Is Nine Dragons Paper (Holdings)'s Balance Sheet?

According to the last reported balance sheet, Nine Dragons Paper (Holdings) had liabilities of CN¥28.4b due within 12 months, and liabilities of CN¥39.6b due beyond 12 months. On the other hand, it had cash of CN¥8.39b and CN¥8.05b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥51.6b.

This deficit casts a shadow over the CN¥27.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Nine Dragons Paper (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 future earnings, more than anything, that will determine Nine Dragons Paper (Holdings)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Nine Dragons Paper (Holdings) had a loss before interest and tax, and actually shrunk its revenue by 6.0%, to CN¥61b. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Nine Dragons Paper (Holdings) produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥54m. 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. Not least because it burned through CN¥10b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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 instance, we've identified 1 warning sign for Nine Dragons Paper (Holdings) that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.