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 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 can see that China Harmony Auto Holding Limited (HKG:3836) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for China Harmony Auto Holding
What Is China Harmony Auto Holding's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2024 China Harmony Auto Holding had CN¥2.38b of debt, an increase on CN¥1.86b, over one year. However, it does have CN¥1.22b in cash offsetting this, leading to net debt of about CN¥1.16b.
How Strong Is China Harmony Auto Holding's Balance Sheet?
The latest balance sheet data shows that China Harmony Auto Holding had liabilities of CN¥4.14b due within a year, and liabilities of CN¥886.4m falling due after that. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥377.1m due within 12 months. So its liabilities total CN¥3.42b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the CN¥1.07b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, China Harmony Auto Holding 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 it is future earnings, more than anything, that will determine China Harmony Auto Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year China Harmony Auto Holding had a loss before interest and tax, and actually shrunk its revenue by 3.4%, to CN¥16b. We would much prefer see growth.
Caveat Emptor
Importantly, China Harmony Auto Holding had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping CN¥320m. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through CN¥374m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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, we've discovered 2 warning signs for China Harmony Auto Holding that you should be aware of before investing here.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.