Is Rare Earth Magnesium Technology Group Holdings (HKG:601) Weighed On By Its Debt Load?

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. Importantly, Rare Earth Magnesium Technology Group Holdings Limited (HKG:601) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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

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

The image below, which you can click on for greater detail, shows that Rare Earth Magnesium Technology Group Holdings had debt of HK$666.4m at the end of June 2023, a reduction from HK$883.8m over a year. However, because it has a cash reserve of HK$32.7m, its net debt is less, at about HK$633.7m.

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

Zooming in on the latest balance sheet data, we can see that Rare Earth Magnesium Technology Group Holdings had liabilities of HK$182.7m due within 12 months and liabilities of HK$623.4m due beyond that. Offsetting these obligations, it had cash of HK$32.7m as well as receivables valued at HK$1.68m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$771.8m.

This deficit casts a shadow over the HK$39.1m 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$248m, which is a fall of 48%. 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$202m. 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. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 5 warning signs with Rare Earth Magnesium Technology Group Holdings (at least 4 which make us uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.