We Think Chuang's China Investments (HKG:298) Can Stay On Top Of Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Chuang's China Investments Limited (HKG:298) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chuang's China Investments

How Much Debt Does Chuang's China Investments Carry?

As you can see below, Chuang's China Investments had HK$1.71b of debt at September 2020, down from HK$2.11b a year prior. But on the other hand it also has HK$2.06b in cash, leading to a HK$344.3m net cash position.

A Look At Chuang's China Investments's Liabilities

According to the last reported balance sheet, Chuang's China Investments had liabilities of HK$1.52b due within 12 months, and liabilities of HK$1.13b due beyond 12 months. Offsetting this, it had HK$2.06b in cash and HK$50.7m in receivables that were due within 12 months. So its liabilities total HK$537.7m more than the combination of its cash and short-term receivables.

Chuang's China Investments has a market capitalization of HK$974.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Chuang's China Investments boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Chuang's China Investments turned things around in the last 12 months, delivering and EBIT of HK$561m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chuang's China Investments will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Chuang's China Investments may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last year, Chuang's China Investments created free cash flow amounting to 7.8% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

Although Chuang's China Investments'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$344.3m. So we don't have any problem with Chuang's China Investments's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Chuang's China Investments has 3 warning signs (and 1 which can't be ignored) we think 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. 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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