Is Chinese People Holdings (HKG:681) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Chinese People Holdings Company Limited (HKG:681) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chinese People Holdings

How Much Debt Does Chinese People Holdings Carry?

The image below, which you can click on for greater detail, shows that Chinese People Holdings had debt of CN¥118.0m at the end of September 2020, a reduction from CN¥157.7m over a year. However, its balance sheet shows it holds CN¥546.8m in cash, so it actually has CN¥428.8m net cash.

How Strong Is Chinese People Holdings's Balance Sheet?

We can see from the most recent balance sheet that Chinese People Holdings had liabilities of CN¥595.5m falling due within a year, and liabilities of CN¥84.7m due beyond that. Offsetting this, it had CN¥546.8m in cash and CN¥145.3m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This short term liquidity is a sign that Chinese People Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Chinese People Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Chinese People Holdings has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Chinese People 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Chinese People Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Chinese People Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Chinese People Holdings has net cash of CN¥428.8m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 8.3% in the last twelve months. So we are not troubled with Chinese People Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Chinese People Holdings is showing 2 warning signs in our investment analysis , you should know about...

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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