Is Chong Fai Jewellery Group Holdings (HKG:8537) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Chong Fai Jewellery Group Holdings Company Limited (HKG:8537) 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. 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.

View our latest analysis for Chong Fai Jewellery Group Holdings

How Much Debt Does Chong Fai Jewellery Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Chong Fai Jewellery Group Holdings had HK$41.0m of debt, an increase on HK$28.3m, over one year. However, because it has a cash reserve of HK$22.3m, its net debt is less, at about HK$18.7m.

How Healthy Is Chong Fai Jewellery Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chong Fai Jewellery Group Holdings had liabilities of HK$52.6m due within 12 months and liabilities of HK$7.67m due beyond that. On the other hand, it had cash of HK$22.3m and HK$1.75m worth of receivables due within a year. So it has liabilities totalling HK$36.3m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$48.0m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chong Fai Jewellery 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.

Over 12 months, Chong Fai Jewellery Group Holdings reported revenue of HK$125m, which is a gain of 4.3%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Chong Fai Jewellery Group Holdings had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$5.2m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of HK$4.8m. So in short it's a really risky stock. 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. Case in point: We've spotted 2 warning signs for Chong Fai Jewellery Group Holdings you should be aware of.

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.

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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.