We Think China Health Group (HKG:673) Has A Fair Chunk 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that China Health Group Limited (HKG:673) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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, 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.

Check out our latest analysis for China Health Group

What Is China Health Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 China Health Group had HK$46.8m of debt, an increase on HK$4.61m, over one year. However, it also had HK$22.7m in cash, and so its net debt is HK$24.0m.

How Healthy Is China Health Group's Balance Sheet?

We can see from the most recent balance sheet that China Health Group had liabilities of HK$117.4m falling due within a year, and liabilities of HK$39.8m due beyond that. Offsetting this, it had HK$22.7m in cash and HK$74.3m in receivables that were due within 12 months. So its liabilities total HK$60.2m more than the combination of its cash and short-term receivables.

Given China Health Group has a market capitalization of HK$539.7m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since China Health Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, China Health Group saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

Caveat Emptor

Importantly, China Health Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost HK$16m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of HK$35m into a profit. So to be blunt we do think it is risky. 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. To that end, you should be aware of the 3 warning signs we've spotted with China Health Group .

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. 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.