Is Chow Tai Fook Jewellery Group (HKG:1929) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Chow Tai Fook Jewellery Group Limited (HKG:1929) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Chow Tai Fook Jewellery Group

What Is Chow Tai Fook Jewellery Group's Debt?

The image below, which you can click on for greater detail, shows that Chow Tai Fook Jewellery Group had debt of HK$12.1b at the end of March 2021, a reduction from HK$22.7b over a year. However, it does have HK$6.29b in cash offsetting this, leading to net debt of about HK$5.85b.

A Look At Chow Tai Fook Jewellery Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Chow Tai Fook Jewellery Group had liabilities of HK$29.1b due within 12 months and liabilities of HK$3.60b due beyond that. Offsetting these obligations, it had cash of HK$6.29b as well as receivables valued at HK$5.73b due within 12 months. So its liabilities total HK$20.7b more than the combination of its cash and short-term receivables.

Given Chow Tai Fook Jewellery Group has a humongous market capitalization of HK$173.0b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chow Tai Fook Jewellery Group has a low net debt to EBITDA ratio of only 0.63. And its EBIT easily covers its interest expense, being 34.8 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Chow Tai Fook Jewellery Group has boosted its EBIT by 82%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chow Tai Fook Jewellery Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Chow Tai Fook Jewellery Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Chow Tai Fook Jewellery Group's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that Chow Tai Fook Jewellery Group is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. 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 - Chow Tai Fook Jewellery Group has 2 warning signs we think you should be aware of.

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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