Is Nanfang Communication Holdings (HKG:1617) Using Too Much Debt?

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.' 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. We note that Nanfang Communication Holdings Limited (HKG:1617) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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.

See our latest analysis for Nanfang Communication Holdings

How Much Debt Does Nanfang Communication Holdings Carry?

The image below, which you can click on for greater detail, shows that Nanfang Communication Holdings had debt of CN¥448.2m at the end of June 2022, a reduction from CN¥543.2m over a year. However, because it has a cash reserve of CN¥326.9m, its net debt is less, at about CN¥121.3m.

A Look At Nanfang Communication Holdings' Liabilities

The latest balance sheet data shows that Nanfang Communication Holdings had liabilities of CN¥796.1m due within a year, and liabilities of CN¥21.2m falling due after that. Offsetting this, it had CN¥326.9m in cash and CN¥501.6m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This surplus suggests that Nanfang Communication Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nanfang Communication 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.

Over 12 months, Nanfang Communication Holdings reported revenue of CN¥608m, which is a gain of 77%, 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.

Caveat Emptor

While we can certainly appreciate Nanfang Communication Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable CN¥88m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. This one is a bit too risky for our liking. 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. Be aware that Nanfang Communication Holdings is showing 3 warning signs in our investment analysis , and 1 of those is 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.