CA Cultural Technology Group (HKG:1566) Is Carrying A Fair Bit Of 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. Importantly, CA Cultural Technology Group Limited (HKG:1566) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 CA Cultural Technology Group

What Is CA Cultural Technology Group's Debt?

As you can see below, CA Cultural Technology Group had HK$594.3m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$65.5m in cash, and so its net debt is HK$528.8m.

How Strong Is CA Cultural Technology Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that CA Cultural Technology Group had liabilities of HK$520.9m due within 12 months and liabilities of HK$526.3m due beyond that. Offsetting these obligations, it had cash of HK$65.5m as well as receivables valued at HK$396.6m due within 12 months. So its liabilities total HK$585.1m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since CA Cultural Technology Group has a market capitalization of HK$2.28b, 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. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CA Cultural Technology Group 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 CA Cultural Technology Group had a loss before interest and tax, and actually shrunk its revenue by 26%, to HK$328m. That makes us nervous, to say the least.

Caveat Emptor

While CA Cultural Technology Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at HK$97m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of HK$21m and the profit of HK$106m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 6 warning signs for CA Cultural Technology Group you should be aware of, and 2 of them shouldn't be ignored.

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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