Here's Why Nanfang Communication Holdings (HKG:1617) Can Afford Some Debt

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.' 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. We note that Nanfang Communication Holdings Limited (HKG:1617) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Nanfang Communication Holdings

What Is Nanfang Communication Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Nanfang Communication Holdings had CN¥543.2m of debt, an increase on CN¥181.4m, over one year. However, it also had CN¥408.6m in cash, and so its net debt is CN¥134.6m.

A Look At Nanfang Communication Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Nanfang Communication Holdings had liabilities of CN¥728.4m due within 12 months and liabilities of CN¥20.5m due beyond that. Offsetting these obligations, it had cash of CN¥408.6m as well as receivables valued at CN¥530.4m due within 12 months. So it actually has CN¥190.1m more liquid assets than total liabilities.

This surplus strongly suggests that Nanfang Communication Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. There's no doubt that we learn most about debt from the balance sheet. But it is Nanfang Communication 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, Nanfang Communication Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥343m, which is a fall of 5.3%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Nanfang Communication Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥54m at the EBIT level. That said, we're impressed with the strong balance sheet liquidity. That will give the company some time and space to grow and develop its business as need be. The company is risky because it will grow into the future to get to profitability and free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 5 warning signs for Nanfang Communication Holdings (2 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.

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.

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