Is Chinlink International Holdings (HKG:997) Using Debt Sensibly?

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.' 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. We can see that Chinlink International Holdings Limited (HKG:997) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chinlink International Holdings

What Is Chinlink International Holdings's Debt?

As you can see below, Chinlink International Holdings had HK$1.97b of debt at March 2023, down from HK$2.14b a year prior. However, it does have HK$90.3m in cash offsetting this, leading to net debt of about HK$1.88b.

How Strong Is Chinlink International Holdings' Balance Sheet?

The latest balance sheet data shows that Chinlink International Holdings had liabilities of HK$2.58b due within a year, and liabilities of HK$491.3m falling due after that. Offsetting these obligations, it had cash of HK$90.3m as well as receivables valued at HK$311.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.67b.

This deficit casts a shadow over the HK$35.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Chinlink International Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chinlink International Holdings 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, Chinlink International Holdings made a loss at the EBIT level, and saw its revenue drop to HK$119m, which is a fall of 36%. That makes us nervous, to say the least.

Caveat Emptor

While Chinlink International 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 HK$52m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$377m in the last year. So we think buying this stock is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Chinlink International Holdings you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.