Is China Asia Valley Group (HKG:63) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 China Asia Valley Group Limited (HKG:63) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Asia Valley Group

What Is China Asia Valley Group's Net Debt?

As you can see below, China Asia Valley Group had HK$223.0m of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$5.50m in cash, and so its net debt is HK$217.5m.

How Healthy Is China Asia Valley Group's Balance Sheet?

The latest balance sheet data shows that China Asia Valley Group had liabilities of HK$246.5m due within a year, and liabilities of HK$732.0k falling due after that. Offsetting this, it had HK$5.50m in cash and HK$5.15m in receivables that were due within 12 months. So its liabilities total HK$236.6m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$281.9m, so it does suggest shareholders should keep an eye on China Asia Valley Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 China Asia Valley Group 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.

In the last year China Asia Valley Group wasn't profitable at an EBIT level, but managed to grow its revenue by 101%, to HK$28m. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Even though China Asia Valley Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost HK$1.7m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$16m. So to be blunt we do think it is risky. 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. For example - China Asia Valley Group has 2 warning signs we think you should be aware of.

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. 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.
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