Is Zhongchang International Holdings Group (HKG:859) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Zhongchang International Holdings Group Limited (HKG:859) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhongchang International Holdings Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhongchang International Holdings Group had HK$792.0m of debt in December 2024, down from HK$870.9m, one year before. However, it does have HK$16.7m in cash offsetting this, leading to net debt of about HK$775.3m.

A Look At Zhongchang International Holdings Group's Liabilities

The latest balance sheet data shows that Zhongchang International Holdings Group had liabilities of HK$806.7m due within a year, and liabilities of HK$18.5m falling due after that. Offsetting this, it had HK$16.7m in cash and HK$2.44m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$806.1m.

The deficiency here weighs heavily on the HK$115.9m 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 definitely think shareholders need to watch this one closely. At the end of the day, Zhongchang International Holdings Group would probably need a major re-capitalization if its creditors were to demand repayment.

See our latest analysis for Zhongchang International Holdings Group

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhongchang International Holdings Group shareholders face the double whammy of a high net debt to EBITDA ratio (32.1), and fairly weak interest coverage, since EBIT is just 0.48 times the interest expense. The debt burden here is substantial. Given the debt load, it's hardly ideal that Zhongchang International Holdings Group's EBIT was pretty flat over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhongchang International Holdings Group will need earnings to service that debt. 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zhongchang International Holdings Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Zhongchang International Holdings Group's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Zhongchang International Holdings Group has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Zhongchang International Holdings Group has 3 warning signs (and 1 which can't be ignored) we think 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.