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. Importantly, D&G Technology Holding Company Limited (HKG:1301) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for D&G Technology Holding
What Is D&G Technology Holding's Net Debt?
As you can see below, at the end of December 2019, D&G Technology Holding had CN¥77.6m of debt, up from CN¥60.1m a year ago. Click the image for more detail. However, it does have CN¥94.9m in cash offsetting this, leading to net cash of CN¥17.4m.
How Strong Is D&G Technology Holding's Balance Sheet?
We can see from the most recent balance sheet that D&G Technology Holding had liabilities of CN¥260.3m falling due within a year, and liabilities of CN¥4.40m due beyond that. On the other hand, it had cash of CN¥94.9m and CN¥247.5m worth of receivables due within a year. So it actually has CN¥77.7m more liquid assets than total liabilities.
This surplus suggests that D&G Technology Holding has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that D&G Technology Holding has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since D&G Technology Holding 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.
In the last year D&G Technology Holding wasn't profitable at an EBIT level, but managed to grow its revenue by 36%, to CN¥446m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is D&G Technology Holding?
While D&G Technology Holding lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow CN¥14m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Keeping in mind its 36% revenue growth over the last year, we think there's a decent chance the company is on track. There's no doubt fast top line growth can cure all manner of ills, for a stock. 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 learn about the 2 warning signs we've spotted with D&G Technology Holding (including 1 which is shouldn't be ignored) .
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. 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. Thank you for reading.