Is Dongwu Cement International (HKG:695) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Dongwu Cement International Limited (HKG:695) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dongwu Cement International

What Is Dongwu Cement International's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Dongwu Cement International had debt of HK$299.7m, up from HK$163.2m in one year. But it also has HK$341.1m in cash to offset that, meaning it has HK$41.5m net cash.

A Look At Dongwu Cement International's Liabilities

Zooming in on the latest balance sheet data, we can see that Dongwu Cement International had liabilities of HK$336.2m due within 12 months and liabilities of HK$200.5m due beyond that. Offsetting these obligations, it had cash of HK$341.1m as well as receivables valued at HK$35.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$159.6m.

Of course, Dongwu Cement International has a market capitalization of HK$905.3m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Dongwu Cement International also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 Dongwu Cement International 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, Dongwu Cement International made a loss at the EBIT level, and saw its revenue drop to HK$273m, which is a fall of 12%. That's not what we would hope to see.

So How Risky Is Dongwu Cement International?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Dongwu Cement International had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through HK$175m of cash and made a loss of HK$44m. But at least it has HK$41.5m on the balance sheet to spend on growth, near-term. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. For example, we've discovered 1 warning sign for Dongwu Cement International that you should be aware of before investing here.

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.