Here's Why Zhong Hua International Holdings (HKG:1064) Has A Meaningful Debt Burden

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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 Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View 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 as of June 2021 Zhong Hua International Holdings had HK$76.8m of debt, an increase on HK$70.4m, over one year. But it also has HK$82.1m in cash to offset that, meaning it has HK$5.32m net cash.

How Healthy Is Zhong Hua International Holdings' Balance Sheet?

The latest balance sheet data shows that Zhong Hua International Holdings had liabilities of HK$127.4m due within a year, and liabilities of HK$1.33b falling due after that. On the other hand, it had cash of HK$82.1m and HK$1.63m worth of receivables due within a year. So it has liabilities totalling HK$1.37b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$92.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Zhong Hua International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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.

We also note that Zhong Hua International Holdings improved its EBIT from a last year's loss to a positive HK$1.2m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhong Hua International Holdings will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhong Hua International Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Zhong Hua 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.

Summing up

While Zhong Hua International Holdings does have more liabilities than liquid assets, it also has net cash of HK$5.32m. The cherry on top was that in converted 713% of that EBIT to free cash flow, bringing in HK$8.2m. Despite the cash, we do find Zhong Hua International Holdings's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. For example Zhong Hua International Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.

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