Is Huanxi Media Group (HKG:1003) Using Too Much Debt?

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, Huanxi Media Group Limited (HKG:1003) does carry debt. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Huanxi Media Group

What Is Huanxi Media Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Huanxi Media Group had HK$116.5m of debt, an increase on HK$92.9m, over one year. However, its balance sheet shows it holds HK$337.9m in cash, so it actually has HK$221.4m net cash.

How Strong Is Huanxi Media Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huanxi Media Group had liabilities of HK$452.9m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of HK$337.9m as well as receivables valued at HK$486.1m due within 12 months. So it actually has HK$371.0m more liquid assets than total liabilities.

This surplus suggests that Huanxi Media Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Huanxi Media Group has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Huanxi Media Group'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, Huanxi Media Group reported revenue of HK$293m, which is a gain of 23%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

So How Risky Is Huanxi Media Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Huanxi Media Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of HK$811m and booked a HK$358m accounting loss. With only HK$221.4m on the balance sheet, it would appear that its going to need to raise capital again soon. Huanxi Media Group's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Huanxi Media Group (1 shouldn't be ignored!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.