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

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. Importantly, Rare Earth Magnesium Technology Group Holdings Limited (HKG:601) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rare Earth Magnesium Technology Group Holdings

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

The image below, which you can click on for greater detail, shows that at December 2023 Rare Earth Magnesium Technology Group Holdings had debt of HK$687.8m, up from HK$643.0m in one year. However, because it has a cash reserve of HK$40.1m, its net debt is less, at about HK$647.7m.

A Look At Rare Earth Magnesium Technology Group Holdings' Liabilities

We can see from the most recent balance sheet that Rare Earth Magnesium Technology Group Holdings had liabilities of HK$184.8m falling due within a year, and liabilities of HK$644.8m due beyond that. On the other hand, it had cash of HK$40.1m and HK$15.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$774.4m.

This deficit casts a shadow over the HK$43.9m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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 it is Rare Earth Magnesium Technology Group 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.

Over 12 months, Rare Earth Magnesium Technology Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$263m, which is a fall of 31%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Rare Earth Magnesium Technology Group Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$173m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. 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 lost HK$424m in the last year. So we think buying this stock is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. 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 can't be ignored.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.