Is Ouhua Energy Holdings (SGX:AJ2) Using Debt In A Risky Way?

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.' 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. As with many other companies Ouhua Energy Holdings Limited (SGX:AJ2) makes use of debt. But should shareholders be worried about its use of debt?

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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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Ouhua Energy Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2024 Ouhua Energy Holdings had CN¥522.4m of debt, an increase on CN¥486.7m, over one year. However, because it has a cash reserve of CN¥173.9m, its net debt is less, at about CN¥348.5m.

How Strong Is Ouhua Energy Holdings' Balance Sheet?

According to the last reported balance sheet, Ouhua Energy Holdings had liabilities of CN¥671.9m due within 12 months, and liabilities of CN¥62.1m due beyond 12 months. On the other hand, it had cash of CN¥173.9m and CN¥168.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥391.7m.

This deficit casts a shadow over the CN¥124.3m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Ouhua Energy Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ouhua Energy Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Check out our latest analysis for Ouhua Energy Holdings

In the last year Ouhua Energy Holdings had a loss before interest and tax, and actually shrunk its revenue by 21%, to CN¥2.7b. To be frank that doesn't bode well.

Caveat Emptor

While Ouhua Energy Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥50m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥69m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. 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 Ouhua Energy Holdings has 4 warning signs (and 3 which can't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.