Would Ching Lee Holdings (HKG:3728) Be Better Off With Less 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Ching Lee Holdings Limited (HKG:3728) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ching Lee Holdings

What Is Ching Lee Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Ching Lee Holdings had HK$68.5m of debt in March 2022, down from HK$89.5m, one year before. On the flip side, it has HK$36.7m in cash leading to net debt of about HK$31.8m.

How Healthy Is Ching Lee Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ching Lee Holdings had liabilities of HK$216.6m due within 12 months and liabilities of HK$461.0k due beyond that. On the other hand, it had cash of HK$36.7m and HK$176.6m worth of receivables due within a year. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Since publicly traded Ching Lee Holdings shares are worth a total of HK$106.4m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ching Lee Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Ching Lee Holdings had a loss before interest and tax, and actually shrunk its revenue by 41%, to HK$537m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Ching Lee Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$23m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$9.2m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ching Lee Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.