We Think Zhi Sheng Group Holdings (HKG:8370) Has A Fair Chunk Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Zhi Sheng Group Holdings Limited (HKG:8370) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhi Sheng Group Holdings

What Is Zhi Sheng Group Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Zhi Sheng Group Holdings had CN¥64.8m of debt, an increase on CN¥7.38m, over one year. However, it does have CN¥31.3m in cash offsetting this, leading to net debt of about CN¥33.5m.

How Healthy Is Zhi Sheng Group Holdings' Balance Sheet?

According to the last reported balance sheet, Zhi Sheng Group Holdings had liabilities of CN¥68.7m due within 12 months, and liabilities of CN¥73.2m due beyond 12 months. Offsetting this, it had CN¥31.3m in cash and CN¥63.4m in receivables that were due within 12 months. So its liabilities total CN¥47.2m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhi Sheng Group Holdings is worth CN¥97.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhi Sheng Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Zhi Sheng Group Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 50%, to CN¥115m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Zhi Sheng Group Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable CN¥43m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥49m into a profit. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Zhi Sheng Group Holdings is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.