We Think Chuang's China Investments (HKG:298) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Chuang's China Investments Limited (HKG:298) 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 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. 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 Chuang's China Investments

What Is Chuang's China Investments's Debt?

The image below, which you can click on for greater detail, shows that Chuang's China Investments had debt of HK$1.71b at the end of September 2020, a reduction from HK$2.11b over a year. But on the other hand it also has HK$2.06b in cash, leading to a HK$344.3m net cash position.

How Strong Is Chuang's China Investments' Balance Sheet?

We can see from the most recent balance sheet that Chuang's China Investments had liabilities of HK$1.52b falling due within a year, and liabilities of HK$1.13b due beyond that. Offsetting this, it had HK$2.06b in cash and HK$35.0m in receivables that were due within 12 months. So it has liabilities totalling HK$553.5m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Chuang's China Investments has a market capitalization of HK$1.09b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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$492m. 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 Chuang's China Investments 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last year, Chuang's China Investments saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

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 although we see some areas for improvement, we're not too worried about Chuang's China Investments's balance sheet. 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. Case in point: We've spotted 4 warning signs for Chuang's China Investments you should be aware of, and 1 of them is significant.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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