Health Check: How Prudently Does Cheuk Nang (Holdings) (HKG:131) Use Debt?

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 Cheuk Nang (Holdings) Limited (HKG:131) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Cheuk Nang (Holdings)

How Much Debt Does Cheuk Nang (Holdings) Carry?

You can click the graphic below for the historical numbers, but it shows that Cheuk Nang (Holdings) had HK$1.25b of debt in December 2021, down from HK$1.30b, one year before. But on the other hand it also has HK$2.02b in cash, leading to a HK$777.5m net cash position.

How Healthy Is Cheuk Nang (Holdings)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cheuk Nang (Holdings) had liabilities of HK$2.89b due within 12 months and liabilities of HK$1.06b due beyond that. On the other hand, it had cash of HK$2.02b and HK$13.7m worth of receivables due within a year. So it has liabilities totalling HK$1.92b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of HK$1.32b, we think shareholders really should watch Cheuk Nang (Holdings)'s debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Given that Cheuk Nang (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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Cheuk Nang (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.

Given it has no significant operating revenue at the moment, shareholders will be hoping Cheuk Nang (Holdings) can make progress and gain better traction for the business, before it runs low on cash.

So How Risky Is Cheuk Nang (Holdings)?

While Cheuk Nang (Holdings) lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$95m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. 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. 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 2 warning signs for Cheuk Nang (Holdings) (of which 1 is a bit unpleasant!) 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.