Is China ZhengTong Auto Services Holdings (HKG:1728) A Risky Investment?

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.' 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 note that China ZhengTong Auto Services Holdings Limited (HKG:1728) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for China ZhengTong Auto Services Holdings

What Is China ZhengTong Auto Services Holdings's Debt?

The image below, which you can click on for greater detail, shows that China ZhengTong Auto Services Holdings had debt of CN¥13.0b at the end of December 2020, a reduction from CN¥19.7b over a year. However, it also had CN¥1.60b in cash, and so its net debt is CN¥11.4b.

A Look At China ZhengTong Auto Services Holdings' Liabilities

We can see from the most recent balance sheet that China ZhengTong Auto Services Holdings had liabilities of CN¥17.4b falling due within a year, and liabilities of CN¥5.24b due beyond that. Offsetting this, it had CN¥1.60b in cash and CN¥4.15b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥16.9b.

This deficit casts a shadow over the CN¥1.53b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China ZhengTong Auto Services Holdings would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China ZhengTong Auto Services Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, China ZhengTong Auto Services Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥17b, which is a fall of 51%. To be frank that doesn't bode well.

Caveat Emptor

Not only did China ZhengTong Auto Services Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥7.3b at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the fact is that it incinerated CN¥226m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So is this a high risk stock? We think so, and we'd avoid it. 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. For example, we've discovered 3 warning signs for China ZhengTong Auto Services Holdings (1 is significant!) that you should be aware of before investing here.

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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