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. As with many other companies Zhongzheng International Company Limited (HKG:943) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Zhongzheng International's Net Debt?
As you can see below, at the end of June 2021, Zhongzheng International had HK$1.96b of debt, up from HK$1.74b a year ago. Click the image for more detail. However, it also had HK$418.7m in cash, and so its net debt is HK$1.54b.
How Strong Is Zhongzheng International's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zhongzheng International had liabilities of HK$2.08b due within 12 months and liabilities of HK$809.2m due beyond that. Offsetting this, it had HK$418.7m in cash and HK$584.8m in receivables that were due within 12 months. So it has liabilities totalling HK$1.89b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the HK$289.5m 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 definitely think shareholders need to watch this one closely. At the end of the day, Zhongzheng International would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. 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.
In the last year Zhongzheng International had a loss before interest and tax, and actually shrunk its revenue by 27%, to HK$126m. To be frank that doesn't bode well.
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$150m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. 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$156m in the last year. So we think buying this stock is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Zhongzheng International you should be aware of, and 1 of them is a bit unpleasant.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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.
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