Is Jiahua Stores Holdings (HKG:602) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Jiahua Stores Holdings Limited (HKG:602) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Jiahua Stores Holdings

What Is Jiahua Stores Holdings's Net Debt?

As you can see below, at the end of June 2023, Jiahua Stores Holdings had CN¥154.3m of debt, up from CN¥120.0m a year ago. Click the image for more detail. However, it does have CN¥41.0m in cash offsetting this, leading to net debt of about CN¥113.3m.

How Strong Is Jiahua Stores Holdings' Balance Sheet?

According to the last reported balance sheet, Jiahua Stores Holdings had liabilities of CN¥213.8m due within 12 months, and liabilities of CN¥575.8m due beyond 12 months. Offsetting this, it had CN¥41.0m in cash and CN¥50.3m in receivables that were due within 12 months. So its liabilities total CN¥698.3m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥50.3m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Jiahua Stores Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiahua Stores 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, Jiahua Stores Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥326m, which is a fall of 8.5%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Jiahua Stores Holdings produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥48m. 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. Sure, the company might have a nice story about how they are going on to a brighter future. But the fact is that it incinerated CN¥13m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Jiahua Stores Holdings you should be aware of, and 3 of them are concerning.

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.