Is Zhong Hua International Holdings (HKG:1064) 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. As with many other companies Zhong Hua International Holdings Limited (HKG:1064) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zhong Hua International Holdings

What Is Zhong Hua International Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Zhong Hua International Holdings had debt of HK$76.1m, up from HK$71.7m in one year. But on the other hand it also has HK$86.4m in cash, leading to a HK$10.3m net cash position.

How Strong Is Zhong Hua International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Zhong Hua International Holdings had liabilities of HK$129.1m falling due within a year, and liabilities of HK$1.32b due beyond that. Offsetting this, it had HK$86.4m in cash and HK$4.15m in receivables that were due within 12 months. So its liabilities total HK$1.36b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$92.8m 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. After all, Zhong Hua International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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 it is Zhong Hua 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.

In the last year Zhong Hua International Holdings had a loss before interest and tax, and actually shrunk its revenue by 41%, to HK$24m. That makes us nervous, to say the least.

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$19m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We're not impressed by its revenue growth, so until we see some positive sustainable EBIT, we consider the stock to be high risk. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Zhong Hua International Holdings has 3 warning signs (and 1 which is concerning) 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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