These 4 Measures Indicate That Chinney Alliance Group (HKG:385) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Chinney Alliance Group Limited (HKG:385) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Chinney Alliance Group had debt of HK$386.1m, up from HK$251.1m in one year. However, its balance sheet shows it holds HK$564.1m in cash, so it actually has HK$178.0m net cash.

How Strong Is Chinney Alliance Group's Balance Sheet?

According to the last reported balance sheet, Chinney Alliance Group had liabilities of HK$1.92b due within 12 months, and liabilities of HK$232.0m due beyond 12 months. Offsetting these obligations, it had cash of HK$564.1m as well as receivables valued at HK$2.28b due within 12 months. So it can boast HK$691.6m more liquid assets than total liabilities.

This luscious liquidity implies that Chinney Alliance Group's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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.

It is just as well that Chinney Alliance Group's load is not too heavy, because its EBIT was down 55% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. During the last three years, Chinney Alliance Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Chinney Alliance Group has net cash of HK$178.0m and plenty of liquid assets. So we are not troubled with Chinney Alliance Group's debt use. There's no doubt that we learn most about debt from the balance sheet. 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 (2 shouldn't be ignored!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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