We Think Changyou Alliance Group (HKG:1039) Has A Fair Chunk Of 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.' 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 can see that Changyou Alliance Group Limited (HKG:1039) does use debt in its business. But should shareholders be worried about its use of debt?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Changyou Alliance Group

What Is Changyou Alliance Group's Debt?

As you can see below, at the end of December 2020, Changyou Alliance Group had CN¥184.2m of debt, up from CN¥127.1m a year ago. Click the image for more detail. On the flip side, it has CN¥154.0m in cash leading to net debt of about CN¥30.2m.

How Strong Is Changyou Alliance Group's Balance Sheet?

The latest balance sheet data shows that Changyou Alliance Group had liabilities of CN¥141.1m due within a year, and liabilities of CN¥86.5m falling due after that. Offsetting these obligations, it had cash of CN¥154.0m as well as receivables valued at CN¥42.5m due within 12 months. So it has liabilities totalling CN¥31.3m more than its cash and near-term receivables, combined.

Of course, Changyou Alliance Group has a market capitalization of CN¥577.7m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Changyou Alliance Group 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.

Over 12 months, Changyou Alliance Group reported revenue of CN¥269m, which is a gain of 32%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Changyou Alliance Group's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable CN¥75m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥105m in negative free cash flow over the last twelve months. So in short it's a really risky stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Changyou Alliance Group you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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