Is Chong Fai Jewellery Group Holdings (HKG:8537) Weighed On By Its Debt Load?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Chong Fai Jewellery Group Holdings Company Limited (HKG:8537) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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.

See our latest analysis for Chong Fai Jewellery Group Holdings

What Is Chong Fai Jewellery Group Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Chong Fai Jewellery Group Holdings had HK$25.9m in debt in September 2023; about the same as the year before. However, it does have HK$15.6m in cash offsetting this, leading to net debt of about HK$10.2m.

A Look At Chong Fai Jewellery Group Holdings' Liabilities

The latest balance sheet data shows that Chong Fai Jewellery Group Holdings had liabilities of HK$45.3m due within a year, and liabilities of HK$1.95m falling due after that. Offsetting these obligations, it had cash of HK$15.6m as well as receivables valued at HK$2.04m due within 12 months. So its liabilities total HK$29.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$26.3m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chong Fai Jewellery Group Holdings's earnings that will influence how the balance sheet holds up in the future. 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$145m, which is a gain of 17%, 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

Over the last twelve months Chong Fai Jewellery Group Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$3.5m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$3.3m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. To that end, you should be aware of the 2 warning signs we've spotted with Chong Fai Jewellery Group Holdings .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.