Is CNQC International Holdings (HKG:1240) 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. As with many other companies CNQC International Holdings Limited (HKG:1240) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for CNQC International Holdings

What Is CNQC International Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that CNQC International Holdings had HK$4.34b of debt in June 2024, down from HK$5.97b, one year before. However, it also had HK$982.3m in cash, and so its net debt is HK$3.35b.

How Strong Is CNQC International Holdings' Balance Sheet?

The latest balance sheet data shows that CNQC International Holdings had liabilities of HK$5.16b due within a year, and liabilities of HK$2.40b falling due after that. On the other hand, it had cash of HK$982.3m and HK$5.39b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.19b.

The deficiency here weighs heavily on the HK$297.4m 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, CNQC International Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.36 times and a disturbingly high net debt to EBITDA ratio of 21.9 hit our confidence in CNQC International Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for CNQC International Holdings is that it turned last year's EBIT loss into a gain of HK$86m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is CNQC 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, CNQC International Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, CNQC International Holdings's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider CNQC International Holdings to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should learn about the 3 warning signs we've spotted with CNQC International Holdings (including 2 which make us uncomfortable) .

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.

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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.