Health Check: How Prudently Does Chuan Holdings (HKG:1420) Use Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Chuan Holdings Limited (HKG:1420) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Chuan Holdings

What Is Chuan Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Chuan Holdings had S$4.90m in debt in June 2021; about the same as the year before. However, its balance sheet shows it holds S$43.2m in cash, so it actually has S$38.3m net cash.

A Look At Chuan Holdings' Liabilities

The latest balance sheet data shows that Chuan Holdings had liabilities of S$19.1m due within a year, and liabilities of S$7.99m falling due after that. Offsetting these obligations, it had cash of S$43.2m as well as receivables valued at S$35.3m due within 12 months. So it can boast S$51.4m more liquid assets than total liabilities.

This excess liquidity is a great indication that Chuan Holdings' balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Chuan Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chuan Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Chuan Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 5.2%, to S$81m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Chuan Holdings?

While Chuan Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow S$3.4m. 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. The next few years will be important as the business matures. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Chuan Holdings is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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