Is Chong Fai Jewellery Group Holdings (HKG:8537) Using Debt Sensibly?

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 can see that Chong Fai Jewellery Group Holdings Company Limited (HKG:8537) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at 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 2020 Chong Fai Jewellery Group Holdings had HK$30.7m of debt, an increase on HK$27.6m, over one year. But it also has HK$36.6m in cash to offset that, meaning it has HK$5.92m net cash.

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

The latest balance sheet data shows that Chong Fai Jewellery Group Holdings had liabilities of HK$58.1m due within a year, and liabilities of HK$3.42m falling due after that. On the other hand, it had cash of HK$36.6m and HK$2.32m worth of receivables due within a year. So its liabilities total HK$22.6m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chong Fai Jewellery Group Holdings has a market capitalization of HK$67.5m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chong Fai Jewellery 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.

In the last year Chong Fai Jewellery Group Holdings had a loss before interest and tax, and actually shrunk its revenue by 40%, to HK$94m. That makes us nervous, to say the least.

So How Risky Is Chong Fai Jewellery Group Holdings?

While Chong Fai Jewellery Group Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$17m. 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Chong Fai Jewellery Group Holdings (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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. 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.
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