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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, China Uptown Group Company Limited (HKG:2330) does carry debt. But is this debt a concern to shareholders?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is China Uptown Group's Net Debt?
As you can see below, at the end of December 2021, China Uptown Group had CN¥128.7m of debt, up from CN¥113.2m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥46.8m, its net debt is less, at about CN¥81.9m.
A Look At China Uptown Group's Liabilities
The latest balance sheet data shows that China Uptown Group had liabilities of CN¥396.1m due within a year, and liabilities of CN¥4.90m falling due after that. On the other hand, it had cash of CN¥46.8m and CN¥64.2m worth of receivables due within a year. So its liabilities total CN¥290.0m more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the CN¥79.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Uptown Group 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 you can't view debt in total isolation; since China Uptown Group 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, China Uptown Group made a loss at the EBIT level, and saw its revenue drop to CN¥130m, which is a fall of 53%. That makes us nervous, to say the least.
While China Uptown Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥105m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost CN¥193m in just last twelve months, and it doesn't have much by way of liquid assets. So while it's not wise to assume the company will fail, we do think it's 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. To that end, you should learn about the 3 warning signs we've spotted with China Uptown Group (including 1 which doesn't sit too well with us) .
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.
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.