Is China Zenith Chemical Group (HKG:362) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Zenith Chemical Group Limited (HKG:362) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for China Zenith Chemical Group

What Is China Zenith Chemical Group's Debt?

The chart below, which you can click on for greater detail, shows that China Zenith Chemical Group had HK$1.25b in debt in December 2021; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is China Zenith Chemical Group's Balance Sheet?

According to the last reported balance sheet, China Zenith Chemical Group had liabilities of HK$982.9m due within 12 months, and liabilities of HK$970.1m due beyond 12 months. Offsetting this, it had HK$10.1m in cash and HK$31.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.91b.

This deficit casts a shadow over the HK$239.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, China Zenith Chemical Group 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 you can't view debt in total isolation; since China Zenith Chemical Group 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.

In the last year China Zenith Chemical Group wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to HK$305m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, China Zenith Chemical Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$270m 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 reality is that it is low on liquid assets relative to liabilities, and it lost HK$371m in the last year. So we think buying this stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 5 warning signs we've spotted with China Zenith Chemical Group (including 2 which are potentially serious) .

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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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.