Is China Ruyi Holdings (HKG:136) A Risky Investment?

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 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. As with many other companies China Ruyi Holdings Limited (HKG:136) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for China Ruyi Holdings

What Is China Ruyi Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 China Ruyi Holdings had CN¥1.77b of debt, an increase on CN¥1.52b, over one year. However, it does have CN¥1.29b in cash offsetting this, leading to net debt of about CN¥481.9m.

A Look At China Ruyi Holdings' Liabilities

The latest balance sheet data shows that China Ruyi Holdings had liabilities of CN¥2.04b due within a year, and liabilities of CN¥3.20b falling due after that. On the other hand, it had cash of CN¥1.29b and CN¥2.05b worth of receivables due within a year. So its liabilities total CN¥1.91b more than the combination of its cash and short-term receivables.

Since publicly traded China Ruyi Holdings shares are worth a total of CN¥16.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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 China Ruyi 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.

In the last year China Ruyi Holdings had a loss before interest and tax, and actually shrunk its revenue by 43%, to CN¥1.3b. That makes us nervous, to say the least.

Caveat Emptor

Not only did China Ruyi Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥128m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥324m of cash over the last year. So to be blunt we think it is risky. 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. For example - China Ruyi Holdings has 2 warning signs we think you should be aware of.

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.