We Think Changyou Alliance Group (HKG:1039) Has A Fair Chunk Of 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.' 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 Changyou Alliance Group Limited (HKG:1039) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Changyou Alliance Group

What Is Changyou Alliance Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2021 Changyou Alliance Group had debt of CN¥206.4m, up from CN¥100.0m in one year. However, it does have CN¥108.5m in cash offsetting this, leading to net debt of about CN¥98.0m.

How Healthy Is Changyou Alliance Group's Balance Sheet?

According to the last reported balance sheet, Changyou Alliance Group had liabilities of CN¥130.6m due within 12 months, and liabilities of CN¥109.6m due beyond 12 months. Offsetting this, it had CN¥108.5m in cash and CN¥38.9m in receivables that were due within 12 months. So its liabilities total CN¥92.7m more than the combination of its cash and short-term receivables.

Changyou Alliance Group has a market capitalization of CN¥394.2m, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Changyou Alliance Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Changyou Alliance Group had a loss before interest and tax, and actually shrunk its revenue by 8.6%, to CN¥227m. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Changyou Alliance Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥82m 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. However, it doesn't help that it burned through CN¥117m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Changyou Alliance Group has 3 warning signs (and 1 which is potentially serious) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.