Is Nine Dragons Paper (Holdings) (HKG:2689) Using Debt In A Risky Way?

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.' 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. As with many other companies Nine Dragons Paper (Holdings) Limited (HKG:2689) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt 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 June 2023 Nine Dragons Paper (Holdings) had debt of CN¥56.8b, up from CN¥44.2b in one year. However, it also had CN¥10.4b in cash, and so its net debt is CN¥46.3b.

A Look At Nine Dragons Paper (Holdings)'s Liabilities

We can see from the most recent balance sheet that Nine Dragons Paper (Holdings) had liabilities of CN¥28.1b falling due within a year, and liabilities of CN¥47.4b due beyond that. Offsetting these obligations, it had cash of CN¥10.4b as well as receivables valued at CN¥10.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥55.0b.

This deficit casts a shadow over the CN¥19.6b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Nine Dragons Paper (Holdings) 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 it is Nine Dragons Paper (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.

In the last year Nine Dragons Paper (Holdings) had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥57b. That's not what we would hope to see.

Caveat Emptor

Not only did Nine Dragons Paper (Holdings)'s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥1.8b at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. 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 lost CN¥2.4b in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. 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 Nine Dragons Paper (Holdings) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.