Health Check: How Prudently Does CHTC Fong's International (HKG:641) Use Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies CHTC Fong's International Company Limited (HKG:641) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CHTC Fong's International

What Is CHTC Fong's International's Net Debt?

As you can see below, CHTC Fong's International had HK$1.71b of debt at December 2020, down from HK$2.06b a year prior. However, it also had HK$342.2m in cash, and so its net debt is HK$1.36b.

A Look At CHTC Fong's International's Liabilities

We can see from the most recent balance sheet that CHTC Fong's International had liabilities of HK$2.65b falling due within a year, and liabilities of HK$203.7m due beyond that. Offsetting these obligations, it had cash of HK$342.2m as well as receivables valued at HK$393.6m due within 12 months. So its liabilities total HK$2.12b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$500.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, CHTC Fong's International would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But it is CHTC Fong's International'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.

Over 12 months, CHTC Fong's International made a loss at the EBIT level, and saw its revenue drop to HK$2.3b, which is a fall of 15%. We would much prefer see growth.

Caveat Emptor

While CHTC Fong's International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$66m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. However, we note that trailing twelve month EBIT is worse than the free cash flow of HK$445m and the profit of HK$19m. So there is arguably potential that the company is going to turn things around. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for CHTC Fong's International (of which 1 is significant!) you should know about.

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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