Is Champion Alliance International Holdings (HKG:1629) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Champion Alliance International Holdings Limited (HKG:1629) does carry debt. But should shareholders be worried about its use of debt?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Champion Alliance International Holdings

What Is Champion Alliance International Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Champion Alliance International Holdings had CN¥41.6m in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds CN¥95.3m in cash, so it actually has CN¥53.6m net cash.

How Strong Is Champion Alliance International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Champion Alliance International Holdings had liabilities of CN¥214.7m falling due within a year, and liabilities of CN¥52.9m due beyond that. Offsetting these obligations, it had cash of CN¥95.3m as well as receivables valued at CN¥45.3m due within 12 months. So it has liabilities totalling CN¥127.1m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥142.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Champion Alliance International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Champion Alliance International Holdings's EBIT fell a jaw-dropping 77% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Champion Alliance International Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Champion Alliance 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. Happily for any shareholders, Champion Alliance International Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Champion Alliance International Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥53.6m. And it impressed us with free cash flow of CN¥71m, being 439% of its EBIT. So while Champion Alliance International Holdings does not have a great balance sheet, it's certainly not too bad. 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. For example - Champion Alliance International Holdings has 3 warning signs 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.