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.' 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. As with many other companies 111, Inc. (NASDAQ:YI) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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. 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.
What Is 111's Net Debt?
As you can see below, at the end of June 2020, 111 had CN¥118.6m of debt, up from CN¥37.3m a year ago. Click the image for more detail. But it also has CN¥703.7m in cash to offset that, meaning it has CN¥585.1m net cash.
How Healthy Is 111's Balance Sheet?
The latest balance sheet data shows that 111 had liabilities of CN¥1.24b due within a year, and liabilities of CN¥59.4m falling due after that. Offsetting these obligations, it had cash of CN¥703.7m as well as receivables valued at CN¥153.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥436.8m.
Of course, 111 has a market capitalization of CN¥3.64b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, 111 boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine 111'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 111 wasn't profitable at an EBIT level, but managed to grow its revenue by 121%, to CN¥5.7b. So there's no doubt that shareholders are cheering for growth
So How Risky Is 111?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year 111 had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through CN¥370.1m of cash and made a loss of CN¥498.2m. Given it only has net cash of CN¥585.1m, the company may need to raise more capital if it doesn't reach break-even soon. Importantly, 111's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with 111 , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you’re looking to trade 111, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.