Is Chen Hsong Holdings (HKG:57) A Risky Investment?

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.' 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 note that Chen Hsong Holdings Limited (HKG:57) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Chen Hsong Holdings

How Much Debt Does Chen Hsong Holdings Carry?

As you can see below, at the end of September 2020, Chen Hsong Holdings had HK$99.7m of debt, up from HK$74.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds HK$1.20b in cash, so it actually has HK$1.10b net cash.

A Look At Chen Hsong Holdings's Liabilities

The latest balance sheet data shows that Chen Hsong Holdings had liabilities of HK$945.9m due within a year, and liabilities of HK$98.4m falling due after that. On the other hand, it had cash of HK$1.20b and HK$1.01b worth of receivables due within a year. So it actually has HK$1.17b more liquid assets than total liabilities.

This luscious liquidity implies that Chen Hsong Holdings'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 Chen Hsong Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Chen Hsong Holdings grew its EBIT by 271% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chen Hsong 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Chen Hsong Holdings 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, Chen Hsong Holdings actually produced more free cash flow than EBIT. 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 Chen Hsong Holdings has HK$1.10b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$143m, being 287% of its EBIT. At the end of the day we're not concerned about Chen Hsong Holdings's debt. 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 2 warning signs for Chen Hsong Holdings that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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