We Think Chow Tai Fook Jewellery Group (HKG:1929) Can Stay On Top Of Its 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 Chow Tai Fook Jewellery Group Limited (HKG:1929) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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.

Check out our latest analysis for Chow Tai Fook Jewellery Group

What Is Chow Tai Fook Jewellery Group's Debt?

As you can see below, Chow Tai Fook Jewellery Group had HK$20.9b of debt at March 2023, down from HK$24.8b a year prior. However, it also had HK$11.7b in cash, and so its net debt is HK$9.21b.

How Healthy Is Chow Tai Fook Jewellery Group's Balance Sheet?

According to the last reported balance sheet, Chow Tai Fook Jewellery Group had liabilities of HK$51.0b due within 12 months, and liabilities of HK$2.96b due beyond 12 months. Offsetting this, it had HK$11.7b in cash and HK$6.24b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$36.0b.

Chow Tai Fook Jewellery Group has a very large market capitalization of HK$147.0b, 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.

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 1.1. And its EBIT easily covers its interest expense, being 26.0 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Chow Tai Fook Jewellery Group's EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chow Tai Fook Jewellery Group'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Chow Tai Fook Jewellery Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Chow Tai Fook Jewellery Group's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its EBIT growth rate has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Chow Tai Fook Jewellery Group can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Chow Tai Fook Jewellery Group that you should be aware of.

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.

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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.