Health Check: How Prudently Does Zhongzheng International (HKG:943) Use Debt?

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.' 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 can see that Zhongzheng International Company Limited (HKG:943) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Zhongzheng International

What Is Zhongzheng International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Zhongzheng International had HK$1.62b of debt, an increase on HK$324.9m, over one year. However, it does have HK$177.1m in cash offsetting this, leading to net debt of about HK$1.44b.

A Look At Zhongzheng International's Liabilities

We can see from the most recent balance sheet that Zhongzheng International had liabilities of HK$1.80b falling due within a year, and liabilities of HK$441.8m due beyond that. Offsetting this, it had HK$177.1m in cash and HK$510.0m in receivables that were due within 12 months. So its liabilities total HK$1.56b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$246.6m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Zhongzheng International would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Zhongzheng International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Zhongzheng International made a loss at the EBIT level, and saw its revenue drop to HK$155m, which is a fall of 22%. To be frank that doesn't bode well.

Caveat Emptor

While Zhongzheng International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$95m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it lost HK$54m in the last year. So we think buying this stock 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. Case in point: We've spotted 2 warning signs for Zhongzheng International you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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