These 4 Measures Indicate That JiaChen Holding Group (HKG:1937) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that JiaChen Holding Group Limited (HKG:1937) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for JiaChen Holding Group

What Is JiaChen Holding Group's Debt?

As you can see below, JiaChen Holding Group had CN¥71.0m of debt at December 2020, down from CN¥113.4m a year prior. On the flip side, it has CN¥64.9m in cash leading to net debt of about CN¥6.07m.

How Healthy Is JiaChen Holding Group's Balance Sheet?

The latest balance sheet data shows that JiaChen Holding Group had liabilities of CN¥123.3m due within a year, and liabilities of CN¥866.0k falling due after that. Offsetting these obligations, it had cash of CN¥64.9m as well as receivables valued at CN¥197.3m due within 12 months. So it can boast CN¥138.2m more liquid assets than total liabilities.

This excess liquidity is a great indication that JiaChen Holding Group's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

JiaChen Holding Group has a very low debt to EBITDA ratio of 0.54 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Shareholders should be aware that JiaChen Holding Group's EBIT was down 78% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is JiaChen 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, JiaChen Holding Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

We weren't impressed with JiaChen Holding Group's interest cover, and its EBIT growth rate made us cautious. But its level of total liabilities was significantly redeeming. Looking at all this data makes us feel a little cautious about JiaChen Holding Group's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. 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 3 warning signs for JiaChen Holding Group (of which 1 shouldn'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. 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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