Is Zhong Hua International Holdings (HKG:1064) A Risky Investment?

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 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. Importantly, Zhong Hua International Holdings Limited (HKG:1064) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhong Hua International Holdings

What Is Zhong Hua International Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhong Hua International Holdings had HK$69.1m of debt in June 2023, down from HK$74.9m, one year before. However, it does have HK$95.9m in cash offsetting this, leading to net cash of HK$26.8m.

How Strong Is Zhong Hua International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Zhong Hua International Holdings had liabilities of HK$132.3m falling due within a year, and liabilities of HK$1.22b due beyond that. Offsetting this, it had HK$95.9m in cash and HK$9.83m in receivables that were due within 12 months. So it has liabilities totalling HK$1.24b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$71.5m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Zhong Hua International Holdings would probably need a major re-capitalization if its creditors were to demand repayment. Given that Zhong Hua International Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Importantly, Zhong Hua International Holdings's EBIT fell a jaw-dropping 84% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Zhong Hua International 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zhong Hua International 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. Over the last three years, Zhong Hua International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Zhong Hua International Holdings does have more liabilities than liquid assets, it also has net cash of HK$26.8m. The cherry on top was that in converted 163% of that EBIT to free cash flow, bringing in HK$26m. Despite its cash we think that Zhong Hua International Holdings seems to struggle to handle its total liabilities, so we are wary of the stock. 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. For example, we've discovered 7 warning signs for Zhong Hua International Holdings (2 are concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.