Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. We can see that Dongfeng Motor Group Company Limited (HKG: 489) uses debt in his business. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Dongfeng Motor Group
What is the debt of Dongfeng Motor Group?
You can click on the graph below for the historical figures, but it shows that Dongfeng Motor Group had a debt of 52.0 billion yen in June 2021, compared to 59.1 billion CN a year earlier. But it also has CN 64.2 billion in cash to compensate for this, which means it has a net cash position of CN 12.1 billion.
How strong is Dongfeng Motor Group’s balance sheet?
The latest balance sheet data shows that Dongfeng Motor Group had CN 141.7 billion debt due within one year, and CN 28.9 billion debt due after that. In return, it had CN 64.2 billion in cash and CN 18.3 billion in receivables due within 12 months. It therefore has liabilities totaling 88.1 billion yen more than its combined cash and short-term receivables.
This deficit casts a shadow over the CN ¥ 52.7b company, like a colossus towering over mere mortals. We would therefore be watching its record closely, without a doubt. After all, Dongfeng Motor Group would likely need a major recapitalization if it were to pay its creditors today. Since Dongfeng Motor Group has more cash than debt, we are quite confident that it can handle its debt, despite having a lot of liabilities altogether.
It was also good to see that despite losing money on the EBIT line last year, Dongfeng Motor Group has turned things around in the past 12 months, delivering EBIT of CNN 165 million. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Dongfeng Motor Group can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. While Dongfeng Motor Group has net cash on its balance sheet, it is still worth examining its ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast it is building. (or erode) that cash balance. Over the past year, Dongfeng Motor Group has spent a lot of money. While this may be the result of spending on growth, it makes debt much riskier.
Although Dongfeng Motor Group’s balance sheet is not particularly strong, due to total liabilities it is clearly positive to see that it has a net cash position of 12.1 billion yen. Despite its liquidity, we believe that Dongfeng Motor Group appears to be struggling to manage its total liabilities, so we are wary of the stock. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Dongfeng Motor Group you should know.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
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