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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangshen Railway Company Limited (HKG:525) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Guangshen Railway's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2022 Guangshen Railway had CN¥563.8m of debt, an increase on none, over one year. But it also has CN¥1.08b in cash to offset that, meaning it has CN¥515.6m net cash.
A Look At Guangshen Railway's Liabilities
We can see from the most recent balance sheet that Guangshen Railway had liabilities of CN¥7.91b falling due within a year, and liabilities of CN¥2.64b due beyond that. Offsetting this, it had CN¥1.08b in cash and CN¥5.33b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.13b.
While this might seem like a lot, it is not so bad since Guangshen Railway has a market capitalization of CN¥12.6b, 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. Despite its noteworthy liabilities, Guangshen Railway boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangshen Railway's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Guangshen Railway wasn't profitable at an EBIT level, but managed to grow its revenue by 7.9%, to CN¥20b. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Guangshen Railway?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Guangshen Railway had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through CN¥1.1b of cash and made a loss of CN¥1.7b. With only CN¥515.6m on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. For riskier companies like Guangshen Railway I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.