Health Check: How Prudently Does Rare Earth Magnesium Technology Group Holdings (HKG:601) Use Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Rare Earth Magnesium Technology Group Holdings Limited (HKG:601) does use debt in its business. But the more important question is: how much risk is that debt creating?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Rare Earth Magnesium Technology Group Holdings

What Is Rare Earth Magnesium Technology Group Holdings's Debt?

As you can see below, Rare Earth Magnesium Technology Group Holdings had HK$659.4m of debt at June 2023, down from HK$883.8m a year prior. On the flip side, it has HK$32.7m in cash leading to net debt of about HK$626.7m.

How Healthy Is Rare Earth Magnesium Technology Group Holdings' Balance Sheet?

According to the last reported balance sheet, Rare Earth Magnesium Technology Group Holdings had liabilities of HK$182.7m due within 12 months, and liabilities of HK$623.4m due beyond 12 months. On the other hand, it had cash of HK$32.7m and HK$1.68m worth of receivables due within a year. So its liabilities total HK$771.8m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$52.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Rare Earth Magnesium Technology Group 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 you can't view debt in total isolation; since Rare Earth Magnesium Technology Group 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 Rare Earth Magnesium Technology Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 48%, to HK$248m. That makes us nervous, to say the least.

Caveat Emptor

While Rare Earth Magnesium Technology Group Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$202m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through HK$14m in the last year. So is this a high risk stock? We think so, and we'd avoid it. 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. Case in point: We've spotted 4 warning signs for Rare Earth Magnesium Technology Group Holdings you should be aware of, and 3 of them are significant.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.