Would Renco Holdings Group (HKG:2323) Be Better Off With Less Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Renco Holdings Group Limited (HKG:2323) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Renco Holdings Group

What Is Renco Holdings Group's Net Debt?

The image below, which you can click on for greater detail, shows that Renco Holdings Group had debt of HK$1.09b at the end of June 2021, a reduction from HK$1.22b over a year. However, it does have HK$189.1m in cash offsetting this, leading to net debt of about HK$904.6m.

How Healthy Is Renco Holdings Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Renco Holdings Group had liabilities of HK$1.12b due within 12 months and liabilities of HK$638.2m due beyond that. Offsetting this, it had HK$189.1m in cash and HK$1.46b in receivables that were due within 12 months. So it has liabilities totalling HK$113.1m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Renco Holdings Group has a market capitalization of HK$242.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Renco Holdings Group'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.

In the last year Renco Holdings Group wasn't profitable at an EBIT level, but managed to grow its revenue by 320%, to HK$466m. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Even though Renco Holdings Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping HK$366m. 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. We would feel better if it turned its trailing twelve month loss of HK$894m into a profit. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Renco Holdings Group is showing 3 warning signs in our investment analysis , and 1 of those is a bit 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.

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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