Is Rare Earth Magnesium Technology Group Holdings (HKG:601) Using Debt In A Risky Way?

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 can see that Rare Earth Magnesium Technology Group Holdings Limited (HKG:601) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 Rare Earth Magnesium Technology Group Holdings

How Much Debt Does Rare Earth Magnesium Technology Group Holdings Carry?

The chart below, which you can click on for greater detail, shows that Rare Earth Magnesium Technology Group Holdings had HK$916.0m in debt in December 2021; about the same as the year before. However, it does have HK$25.5m in cash offsetting this, leading to net debt of about HK$890.5m.

A Look At Rare Earth Magnesium Technology Group Holdings' Liabilities

The latest balance sheet data shows that Rare Earth Magnesium Technology Group Holdings had liabilities of HK$1.09b due within a year, and liabilities of HK$78.0m falling due after that. On the other hand, it had cash of HK$25.5m and HK$156.6m worth of receivables due within a year. So it has liabilities totalling HK$989.6m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$230.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Rare Earth Magnesium Technology Group 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 Rare Earth Magnesium Technology Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Rare Earth Magnesium Technology Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$416m, which is a fall of 44%. To be frank that doesn't bode well.

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$88m at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized HK$6.6m in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. There's no doubt that we learn most about debt from the balance sheet. 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 2 of them are concerning.

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.

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.