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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that Zhong Hua International Holdings Limited (HKG:1064) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Zhong Hua International Holdings

What Is Zhong Hua International Holdings's Debt?

The image below, which you can click on for greater detail, shows that Zhong Hua International Holdings had debt of HK$70.4m at the end of June 2020, a reduction from HK$76.6m over a year. However, its balance sheet shows it holds HK$83.1m in cash, so it actually has HK$12.7m net cash.

How Strong Is Zhong Hua International Holdings's Balance Sheet?

The latest balance sheet data shows that Zhong Hua International Holdings had liabilities of HK$115.8m due within a year, and liabilities of HK$1.23b falling due after that. Offsetting this, it had HK$83.1m in cash and HK$5.74m in receivables that were due within 12 months. So it has liabilities totalling HK$1.25b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$103.5m 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. Zhong Hua International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. 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.

In the last year Zhong Hua International Holdings had a loss before interest and tax, and actually shrunk its revenue by 50%, to HK$27m. To be frank that doesn't bode well.

So How Risky Is Zhong Hua International Holdings?

While Zhong Hua International Holdings lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$24m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. For instance, we've identified 5 warning signs for Zhong Hua International Holdings (1 is a bit unpleasant) you should be aware of.

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. 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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