Zhou Hei Ya International Holdings (HKG:1458) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Zhou Hei Ya International Holdings Company Limited (HKG:1458) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Zhou Hei Ya International Holdings

How Much Debt Does Zhou Hei Ya International Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Zhou Hei Ya International Holdings had debt of CN¥1.64b, up from none in one year. However, it does have CN¥3.42b in cash offsetting this, leading to net cash of CN¥1.78b.

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

Zooming in on the latest balance sheet data, we can see that Zhou Hei Ya International Holdings had liabilities of CN¥1.26b due within 12 months and liabilities of CN¥1.55b due beyond that. Offsetting this, it had CN¥3.42b in cash and CN¥66.3m in receivables that were due within 12 months. So it can boast CN¥676.0m 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.

The modesty of its debt load may become crucial for Zhou Hei Ya International Holdings if management cannot prevent a repeat of the 85% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhou Hei Ya International Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhou Hei Ya International Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Zhou Hei Ya International Holdings created free cash flow amounting to 15% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Zhou Hei Ya International Holdings has net cash of CN¥1.78b, as well as more liquid assets than liabilities. So we are not troubled with Zhou Hei Ya International Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Zhou Hei Ya International Holdings that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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