Is Zhonghua Gas Holdings (HKG:8246) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Zhonghua Gas Holdings Limited (HKG:8246) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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 Zhonghua Gas Holdings

How Much Debt Does Zhonghua Gas Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Zhonghua Gas Holdings had debt of CN¥98.2m, up from none in one year. However, it also had CN¥85.5m in cash, and so its net debt is CN¥12.7m.

How Healthy Is Zhonghua Gas Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhonghua Gas Holdings had liabilities of CN¥141.0m due within 12 months and liabilities of CN¥99.5m due beyond that. On the other hand, it had cash of CN¥85.5m and CN¥379.1m worth of receivables due within a year. So it actually has CN¥224.1m more liquid assets than total liabilities.

This surplus strongly suggests that Zhonghua Gas Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhonghua Gas 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.

In the last year Zhonghua Gas Holdings had a loss before interest and tax, and actually shrunk its revenue by 29%, to CN¥244m. That makes us nervous, to say the least.

Caveat Emptor

While Zhonghua Gas Holdings'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 CN¥146m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Zhonghua Gas Holdings , and understanding them should be part of your investment process.

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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