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. 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 Zhejiang United Investment Holdings Group Limited (HKG:8366) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zhejiang United Investment Holdings Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Zhejiang United Investment Holdings Group had HK$1.20m of debt in April 2019, down from HK$2.31m, one year before. But it also has HK$33.7m in cash to offset that, meaning it has HK$32.5m net cash.
How Strong Is Zhejiang United Investment Holdings Group's Balance Sheet?
The latest balance sheet data shows that Zhejiang United Investment Holdings Group had liabilities of HK$74.5m due within a year, and liabilities of HK$4.0k falling due after that. Offsetting this, it had HK$33.7m in cash and HK$82.7m in receivables that were due within 12 months. So it actually has HK$41.8m more liquid assets than total liabilities.
This short term liquidity is a sign that Zhejiang United Investment Holdings Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang United Investment Holdings Group has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zhejiang United Investment Holdings Group will need earnings to service that debt. 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.
Over 12 months, Zhejiang United Investment Holdings Group reported revenue of HK$169m, which is a gain of 17%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is Zhejiang United Investment Holdings Group?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Zhejiang United Investment Holdings Group had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of HK$3.4m and booked a HK$13m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of HK$32.5m. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Zhejiang United Investment Holdings Group's profit, revenue, and operating cashflow have changed over the last few years.
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
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