Is Central Holding Group (HKG:1735) Using Too Much Debt?

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 Central Holding Group Co. Ltd. (HKG:1735) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Central Holding Group

What Is Central Holding Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Central Holding Group had HK$28.0m of debt, an increase on none, over one year. But it also has HK$62.5m in cash to offset that, meaning it has HK$34.5m net cash.

How Strong Is Central Holding Group's Balance Sheet?

We can see from the most recent balance sheet that Central Holding Group had liabilities of HK$559.0m falling due within a year, and liabilities of HK$117.0m due beyond that. Offsetting this, it had HK$62.5m in cash and HK$483.9m in receivables that were due within 12 months. So its liabilities total HK$129.6m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Central Holding Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the HK$18.2b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Central Holding Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Central Holding Group made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$4.6m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Central Holding Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Central Holding Group 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. Over the last year, Central Holding Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Central Holding Group has HK$34.5m in net cash. And it impressed us with free cash flow of HK$91m, being 1,974% of its EBIT. So we are not troubled with Central Holding Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Central Holding Group has 1 warning sign we think you should be aware of.

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.