Chinney Alliance Group (HKG:385) Has A Rock Solid Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Chinney Alliance Group Limited (HKG:385) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chinney Alliance Group

What Is Chinney Alliance Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Chinney Alliance Group had debt of HK$528.6m, up from HK$471.5m in one year. However, its balance sheet shows it holds HK$596.6m in cash, so it actually has HK$68.0m net cash.

How Strong Is Chinney Alliance Group's Balance Sheet?

We can see from the most recent balance sheet that Chinney Alliance Group had liabilities of HK$2.26b falling due within a year, and liabilities of HK$168.1m due beyond that. On the other hand, it had cash of HK$596.6m and HK$2.30b worth of receivables due within a year. So it actually has HK$468.4m more liquid assets than total liabilities.

This surplus strongly suggests that Chinney Alliance Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Chinney Alliance Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Chinney Alliance Group grew its EBIT by 118% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chinney Alliance 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Chinney Alliance 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 three years, Chinney Alliance Group barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Chinney Alliance Group has net cash of HK$68.0m and plenty of liquid assets. And we liked the look of last year's 118% year-on-year EBIT growth. So is Chinney Alliance Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Chinney Alliance Group (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.