Is Chen Hsong Holdings (HKG:57) Using Too Much Debt?

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. 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?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Chen Hsong Holdings

What Is Chen Hsong Holdings's Debt?

The image below, which you can click on for greater detail, shows that Chen Hsong Holdings had debt of HK$23.5m at the end of September 2021, a reduction from HK$99.7m over a year. However, it does have HK$956.6m in cash offsetting this, leading to net cash of HK$933.1m.

How Healthy Is Chen Hsong Holdings' Balance Sheet?

According to the last reported balance sheet, Chen Hsong Holdings had liabilities of HK$1.24b due within 12 months, and liabilities of HK$113.2m due beyond 12 months. Offsetting this, it had HK$956.6m in cash and HK$1.36b in receivables that were due within 12 months. So it can boast HK$963.2m more liquid assets than total liabilities.

This surplus strongly suggests that Chen Hsong Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Chen Hsong Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Chen Hsong Holdings grew its EBIT by 730% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is Chen Hsong Holdings'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Chen Hsong Holdings 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. During the last three years, Chen Hsong Holdings produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Chen Hsong Holdings has HK$933.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 730% year-on-year EBIT growth. At the end of the day we're not concerned about Chen Hsong Holdings's debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Chen Hsong Holdings (1 makes us a bit uncomfortable!) 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. 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.