Zhong Hua International Holdings (HKG:1064) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We note that Zhong Hua International Holdings Limited (HKG:1064) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Debt?

The chart below, which you can click on for greater detail, shows that Zhong Hua International Holdings had HK$78.1m in debt in December 2021; about the same as the year before. But it also has HK$93.2m in cash to offset that, meaning it has HK$15.1m net cash.

A Look At Zhong Hua International Holdings' Liabilities

According to the last reported balance sheet, Zhong Hua International Holdings had liabilities of HK$153.0m due within 12 months, and liabilities of HK$1.35b due beyond 12 months. On the other hand, it had cash of HK$93.2m and HK$21.6m worth of receivables due within a year. So its liabilities total HK$1.39b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$67.1m company, like a colossus towering over mere mortals. 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.

It was also good to see that despite losing money on the EBIT line last year, Zhong Hua International Holdings turned things around in the last 12 months, delivering and EBIT of HK$26m. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

Although Zhong Hua International Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$15.1m. And it impressed us with free cash flow of HK$22m, being 85% of its EBIT. So while Zhong Hua International Holdings does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Zhong Hua International Holdings (of which 2 are significant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.