Is Chinney Alliance Group (HKG:385) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Chinney Alliance Group Limited (HKG:385) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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 2020 Chinney Alliance Group had debt of HK$224.7m, up from HK$167.2m in one year. However, its balance sheet shows it holds HK$561.9m in cash, so it actually has HK$337.2m net cash.

A Look At Chinney Alliance Group's Liabilities

The latest balance sheet data shows that Chinney Alliance Group had liabilities of HK$1.48b due within a year, and liabilities of HK$152.6m falling due after that. On the other hand, it had cash of HK$561.9m and HK$1.94b worth of receivables due within a year. So it actually has HK$866.3m more liquid assets than total liabilities.

This surplus liquidity suggests that Chinney Alliance Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Chinney Alliance Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Chinney Alliance Group's saving grace is its low debt levels, because its EBIT has tanked 48% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chinney Alliance 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. Chinney Alliance Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Chinney Alliance Group recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Chinney Alliance Group has HK$337.2m in net cash and a strong balance sheet. So we are not troubled with Chinney Alliance Group's debt use. 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. For example, we've discovered 4 warning signs for Chinney Alliance Group (1 is concerning!) that you should be aware of before investing here.

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. 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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