Is Creative China Holdings (HKG:8368) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Creative China Holdings Limited (HKG:8368) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, 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.

View our latest analysis for Creative China Holdings

What Is Creative China Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Creative China Holdings had debt of CN¥23.8m at the end of June 2023, a reduction from CN¥35.6m over a year. But it also has CN¥34.9m in cash to offset that, meaning it has CN¥11.1m net cash.

How Healthy Is Creative China Holdings' Balance Sheet?

We can see from the most recent balance sheet that Creative China Holdings had liabilities of CN¥193.4m falling due within a year, and liabilities of CN¥421.0k due beyond that. Offsetting these obligations, it had cash of CN¥34.9m as well as receivables valued at CN¥191.2m due within 12 months. So it can boast CN¥32.3m more liquid assets than total liabilities.

This surplus suggests that Creative China Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Creative China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Creative China Holdings grew its EBIT by 191% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Creative China Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Creative China 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. Considering the last three years, Creative China Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Creative China Holdings has CN¥11.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 191% over the last year. So we are not troubled with Creative China Holdings's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Creative China Holdings (of which 2 are potentially serious!) you should know about.

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. 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.