Is Chong Fai Jewellery Group Holdings (HKG:8537) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Chong Fai Jewellery Group Holdings Company Limited (HKG:8537) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Chong Fai Jewellery Group Holdings

What Is Chong Fai Jewellery Group Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Chong Fai Jewellery Group Holdings had HK$28.3m of debt in March 2022, down from HK$31.3m, one year before. However, its balance sheet shows it holds HK$29.6m in cash, so it actually has HK$1.30m net cash.

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

We can see from the most recent balance sheet that Chong Fai Jewellery Group Holdings had liabilities of HK$46.6m falling due within a year, and liabilities of HK$9.63m due beyond that. On the other hand, it had cash of HK$29.6m and HK$1.32m worth of receivables due within a year. So it has liabilities totalling HK$25.3m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$42.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Chong Fai Jewellery Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! 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 if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Chong Fai Jewellery Group Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 5.5%, to HK$107m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Chong Fai Jewellery Group Holdings?

Although Chong Fai Jewellery Group Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$2.6m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.