Is China Strategic Holdings (HKG:235) A Risky Investment?

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. As with many other companies China Strategic Holdings Limited (HKG:235) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for China Strategic Holdings

What Is China Strategic Holdings's Debt?

The image below, which you can click on for greater detail, shows that China Strategic Holdings had debt of HK$692.1m at the end of December 2021, a reduction from HK$2.00b over a year. However, it does have HK$1.55b in cash offsetting this, leading to net cash of HK$861.2m.

How Strong Is China Strategic Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Strategic Holdings had liabilities of HK$738.0m falling due within a year, and liabilities of HK$7.89m due beyond that. On the other hand, it had cash of HK$1.55b and HK$1.47b worth of receivables due within a year. So it can boast HK$2.27b more liquid assets than total liabilities.

This surplus strongly suggests that China Strategic Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that China Strategic Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, China Strategic Holdings's EBIT launched higher than Elon Musk, gaining a whopping 593% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Strategic 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While China Strategic 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, China Strategic Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case China Strategic Holdings has HK$861.2m in net cash and a strong balance sheet. And it impressed us with free cash flow of HK$639m, being 565% of its EBIT. When it comes to China Strategic Holdings's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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 China Strategic Holdings is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.