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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, CHTC Fong's International Company Limited (HKG:641) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for CHTC Fong's International

How Much Debt Does CHTC Fong's International Carry?

The chart below, which you can click on for greater detail, shows that CHTC Fong's International had HK$1.33b in debt in June 2024; about the same as the year before. However, it does have HK$262.2m in cash offsetting this, leading to net debt of about HK$1.07b.

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$2.05b falling due within a year, and liabilities of HK$362.7m due beyond that. On the other hand, it had cash of HK$262.2m and HK$337.1m worth of receivables due within a year. So it has liabilities totalling HK$1.81b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$357.6m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, CHTC Fong's International would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. 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$1.8b, which is a fall of 13%. 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. Its EBIT loss was a whopping HK$125m. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through HK$64m in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example CHTC Fong's International has 3 warning signs (and 2 which can't be ignored) we think 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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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.