Is China Eco-Farming (HKG:8166) Using Debt Sensibly?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that China Eco-Farming Limited (HKG:8166) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Eco-Farming

What Is China Eco-Farming's Net Debt?

As you can see below, China Eco-Farming had HK$47.1m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$11.6m in cash leading to net debt of about HK$35.5m.

How Strong Is China Eco-Farming's Balance Sheet?

The latest balance sheet data shows that China Eco-Farming had liabilities of HK$108.3m due within a year, and liabilities of HK$1.59m falling due after that. Offsetting these obligations, it had cash of HK$11.6m as well as receivables valued at HK$54.4m due within 12 months. So its liabilities total HK$43.9m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$20.0m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, China Eco-Farming 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 China Eco-Farming'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 China Eco-Farming wasn't profitable at an EBIT level, but managed to grow its revenue by 84%, to HK$65m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though China Eco-Farming 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$32m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$37m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example China Eco-Farming has 4 warning signs (and 2 which are a bit concerning) we think you should know about.

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.