Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think about the risk level of a business, we always like to look at its use of debt, because debt overload can lead to bankruptcy. Mostly, Nanfang Communication Holdings Limited (HKG: 1617) carries a debt. But does this debt worry shareholders?
Why is debt risky?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. Of course, many companies use debt to finance their growth without negative consequences. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
Check out our latest review for Nanfang Communication Holdings
What is the net debt of Nanfang Communication Holdings?
The image below, which you can click for more details, shows that as of December 2020, Nanfang Communication Holdings had a debt of CNY 295.2 million, compared to CN 244.0 million in one year. However, he also had CN 207.2 million in cash, so his net debt was CN 88.0 million.
A look at the responsibilities of Nanfang Communication Holdings
The latest balance sheet data shows that Nanfang Communication Holdings had a liability of CN 495.6 million maturing within one year, and a liability of CN 20.7 million maturing thereafter. In return, he had 207.2 million yen in cash and 398.8 million yen in receivables due within 12 months. He can therefore boast of having CNY 89.7 million more in liquid assets than total Liabilities.
This surplus suggests that Nanfang Communication Holdings is using debt in a way that seems both safe and conservative. Due to its strong net asset position, it should not encounter any problems with its lenders. The balance sheet is clearly the area to focus on when analyzing debt. But you cannot view the debt in total isolation; since Nanfang Communication Holdings will need revenue to service this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Over the past year, Nanfang Communication Holdings recorded a loss before interest and taxes and actually reduced its revenue by 29%, to 380 million yen. To be frank, that doesn’t bode well.
While Nanfang Communication Holdings’ decline in revenue is about as comforting as a wet blanket, arguably its earnings before interest and tax losses (EBIT) are even less attractive. Indeed, it lost 43 million CNY very considerable in terms of EBIT. On a more positive note, the company has liquid assets, so it has a bit of time to improve its operations before debt becomes a serious problem. Still, we would be more encouraged to study the business in depth if it already had free cash flow. This one is a bit too risky for our liking. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. Concrete example: we have spotted 3 warning signs for Nanfang Communication Holdings you need to be aware of that, and one of them is concerning.
At the end of the day, it’s often best to focus on businesses with no net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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