Confidence Intelligence Holdings (HKG:1967) Has A Pretty Healthy Balance Sheet

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. Importantly, Confidence Intelligence Holdings Limited (HKG:1967) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Confidence Intelligence Holdings

What Is Confidence Intelligence Holdings's Debt?

As you can see below, at the end of December 2020, Confidence Intelligence Holdings had CN¥13.9m of debt, up from CN¥8.20m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥109.0m in cash, so it actually has CN¥95.1m net cash.

How Healthy Is Confidence Intelligence Holdings' Balance Sheet?

According to the last reported balance sheet, Confidence Intelligence Holdings had liabilities of CN¥72.6m due within 12 months, and liabilities of CN¥19.8m due beyond 12 months. Offsetting this, it had CN¥109.0m in cash and CN¥70.5m in receivables that were due within 12 months. So it can boast CN¥87.1m more liquid assets than total liabilities.

This surplus suggests that Confidence Intelligence Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Confidence Intelligence Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Confidence Intelligence Holdings if management cannot prevent a repeat of the 64% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Confidence Intelligence Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Confidence Intelligence Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Confidence Intelligence Holdings recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Confidence Intelligence Holdings has CN¥95.1m in net cash and a decent-looking balance sheet. So we are not troubled with Confidence Intelligence Holdings's debt use. 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 example, we've discovered 3 warning signs for Confidence Intelligence Holdings (1 can't be ignored!) that you should be aware of before investing here.

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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