We Think Chuan Holdings (HKG:1420) Can Manage Its Debt With Ease

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 Chuan Holdings Limited (HKG:1420) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Chuan Holdings

What Is Chuan Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Chuan Holdings had debt of S$2.45m at the end of June 2023, a reduction from S$3.69m over a year. However, it does have S$22.3m in cash offsetting this, leading to net cash of S$19.9m.

How Strong Is Chuan Holdings' Balance Sheet?

We can see from the most recent balance sheet that Chuan Holdings had liabilities of S$20.7m falling due within a year, and liabilities of S$2.90m due beyond that. Offsetting these obligations, it had cash of S$22.3m as well as receivables valued at S$47.9m due within 12 months. So it can boast S$46.7m more liquid assets than total liabilities.

This surplus strongly suggests that Chuan Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). 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!

Although Chuan Holdings made a loss at the EBIT level, last year, it was also good to see that it generated S$259k in EBIT over the last twelve months. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Chuan Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Chuan Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Chuan Holdings has net cash of S$19.9m and plenty of liquid assets. The cherry on top was that in converted 1,446% of that EBIT to free cash flow, bringing in S$3.7m. So we don't think Chuan Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Chuan Holdings (of which 2 can't be ignored!) you should know about.

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.