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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Shandong Bohui Paper Industry Co.,Ltd. (SHSE:600966) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shandong Bohui Paper IndustryLtd's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Shandong Bohui Paper IndustryLtd had debt of CN¥8.19b, up from CN¥7.76b in one year. However, it also had CN¥2.63b in cash, and so its net debt is CN¥5.56b.
How Strong Is Shandong Bohui Paper IndustryLtd's Balance Sheet?
According to the last reported balance sheet, Shandong Bohui Paper IndustryLtd had liabilities of CN¥12.0b due within 12 months, and liabilities of CN¥2.83b due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.63b as well as receivables valued at CN¥2.15b due within 12 months. So its liabilities total CN¥10.1b more than the combination of its cash and short-term receivables.
When you consider that this deficiency exceeds the company's CN¥6.79b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Shandong Bohui Paper IndustryLtd'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.
Over 12 months, Shandong Bohui Paper IndustryLtd saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.
Caveat Emptor
Over the last twelve months Shandong Bohui Paper IndustryLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥359m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥1.2b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shandong Bohui Paper IndustryLtd .
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.