Is Huajin International Holdings (HKG:2738) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Huajin International Holdings Limited (HKG:2738) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Huajin International Holdings

What Is Huajin International Holdings's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Huajin International Holdings had debt of CN¥1.54b, up from CN¥1.37b in one year. However, it does have CN¥60.3m in cash offsetting this, leading to net debt of about CN¥1.48b.

How Strong Is Huajin International Holdings' Balance Sheet?

According to the last reported balance sheet, Huajin International Holdings had liabilities of CN¥1.94b due within 12 months, and liabilities of CN¥406.8m due beyond 12 months. On the other hand, it had cash of CN¥60.3m and CN¥260.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.03b.

This deficit casts a shadow over the CN¥945.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Huajin International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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 Huajin International Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Huajin International Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 21%, to CN¥5.0b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Huajin International Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost CN¥21m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥247m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Huajin International 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.