Nine Dragons Paper (Holdings) (HKG:2689) Seems To Be Using A Lot Of Debt

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 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 should shareholders be worried about its use of debt?

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Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Nine Dragons Paper (Holdings)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2025 Nine Dragons Paper (Holdings) had CN¥75.4b of debt, an increase on CN¥67.2b, over one year. However, because it has a cash reserve of CN¥11.3b, its net debt is less, at about CN¥64.1b.

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

The latest balance sheet data shows that Nine Dragons Paper (Holdings) had liabilities of CN¥32.5b due within a year, and liabilities of CN¥66.0b falling due after that. Offsetting these obligations, it had cash of CN¥11.3b as well as receivables valued at CN¥12.8b due within 12 months. So its liabilities total CN¥74.3b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥24.6b 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'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.

Check out our latest analysis for Nine Dragons Paper (Holdings)

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.3 times and a disturbingly high net debt to EBITDA ratio of 8.9 hit our confidence in Nine Dragons Paper (Holdings) like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Nine Dragons Paper (Holdings) boosted its EBIT by a silky 42% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last two years, Nine Dragons Paper (Holdings) burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Nine Dragons Paper (Holdings)'s conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. We're quite clear that we consider Nine Dragons Paper (Holdings) to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 1 warning sign for Nine Dragons Paper (Holdings) that you should be aware of before investing here.

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.