China Asia Valley Group (HKG:63) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that China Asia Valley Group Limited (HKG:63) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for China Asia Valley Group

What Is China Asia Valley Group's Net Debt?

The chart below, which you can click on for greater detail, shows that China Asia Valley Group had HK$229.4m in debt in June 2023; about the same as the year before. However, it does have HK$5.72m in cash offsetting this, leading to net debt of about HK$223.6m.

How Healthy Is China Asia Valley Group's Balance Sheet?

The latest balance sheet data shows that China Asia Valley Group had liabilities of HK$244.9m due within a year, and liabilities of HK$1.03m falling due after that. Offsetting these obligations, it had cash of HK$5.72m as well as receivables valued at HK$7.60m due within 12 months. So it has liabilities totalling HK$232.7m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$273.5m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is China Asia Valley Group'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 China Asia Valley Group had a loss before interest and tax, and actually shrunk its revenue by 5.3%, to HK$39m. We would much prefer see growth.

Caveat Emptor

Over the last twelve months China Asia Valley Group produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at HK$832k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$2.2m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with China Asia Valley Group (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.