Is JiaChen Holding Group (HKG:1937) A Risky Investment?

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. We can see that JiaChen Holding Group Limited (HKG:1937) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for JiaChen Holding Group

How Much Debt Does JiaChen Holding Group Carry?

The image below, which you can click on for greater detail, shows that at December 2021 JiaChen Holding Group had debt of CN¥81.0m, up from CN¥71.0m in one year. However, because it has a cash reserve of CN¥71.2m, its net debt is less, at about CN¥9.83m.

How Strong Is JiaChen Holding Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that JiaChen Holding Group had liabilities of CN¥131.6m due within 12 months and liabilities of CN¥125.0k due beyond that. On the other hand, it had cash of CN¥71.2m and CN¥222.2m worth of receivables due within a year. So it actually has CN¥161.7m more liquid assets than total liabilities.

It's good to see that JiaChen Holding Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

JiaChen Holding Group has a low net debt to EBITDA ratio of only 0.27. And its EBIT easily covers its interest expense, being 10.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that JiaChen Holding Group grew its EBIT by 450% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since JiaChen Holding Group 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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, JiaChen Holding Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

The good news is that JiaChen Holding Group's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Zooming out, JiaChen Holding Group seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. For example JiaChen Holding Group has 3 warning signs (and 1 which is concerning) we think 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.