Is Zhou Hei Ya International Holdings (HKG:1458) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that Zhou Hei Ya International Holdings Company Limited (HKG:1458) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Zhou Hei Ya International Holdings

What Is Zhou Hei Ya International Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Zhou Hei Ya International Holdings had CN¥1.35b of debt, an increase on CN¥339.4m, over one year. But on the other hand it also has CN¥3.50b in cash, leading to a CN¥2.15b net cash position.

How Strong Is Zhou Hei Ya International Holdings' Balance Sheet?

The latest balance sheet data shows that Zhou Hei Ya International Holdings had liabilities of CN¥1.02b due within a year, and liabilities of CN¥1.58b falling due after that. On the other hand, it had cash of CN¥3.50b and CN¥189.5m worth of receivables due within a year. So it can boast CN¥1.08b more liquid assets than total liabilities.

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

Even more impressive was the fact that Zhou Hei Ya International Holdings grew its EBIT by 154% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhou Hei Ya International Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhou Hei Ya International 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. Over the last three years, Zhou Hei Ya International Holdings recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Zhou Hei Ya International Holdings has CN¥2.15b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in CN¥675m. So we don't think Zhou Hei Ya International Holdings's use of debt is risky. 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. For example - Zhou Hei Ya International Holdings has 1 warning sign we think you should be aware of.

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.