Would Zhi Sheng Group Holdings (HKG:8370) Be Better Off With Less 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.' 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. As with many other companies Zhi Sheng Group Holdings Limited (HKG:8370) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhi Sheng Group Holdings

What Is Zhi Sheng Group Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Zhi Sheng Group Holdings had CN¥70.8m of debt, an increase on CN¥58.4m, over one year. However, it also had CN¥33.8m in cash, and so its net debt is CN¥37.0m.

How Strong Is Zhi Sheng Group Holdings' Balance Sheet?

According to the last reported balance sheet, Zhi Sheng Group Holdings had liabilities of CN¥34.7m due within 12 months, and liabilities of CN¥77.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥33.8m as well as receivables valued at CN¥27.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥50.9m.

This deficit is considerable relative to its market capitalization of CN¥63.1m, so it does suggest shareholders should keep an eye on Zhi Sheng Group Holdings' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhi Sheng Group 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.

Over 12 months, Zhi Sheng Group Holdings reported revenue of CN¥111m, which is a gain of 49%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

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¥24m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥24m of cash over the last year. So suffice it to say 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 2 warning signs in our investment analysis , 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.