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. Importantly, China Travel International Investment Hong Kong Limited (HKG:308) does carry debt. But should shareholders be worried about its use of debt?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is China Travel International Investment Hong Kong's Debt?
The image below, which you can click on for greater detail, shows that China Travel International Investment Hong Kong had debt of HK$82.4m at the end of June 2019, a reduction from HK$886.2m over a year. However, its balance sheet shows it holds HK$3.83b in cash, so it actually has HK$3.74b net cash.
How Strong Is China Travel International Investment Hong Kong's Balance Sheet?
According to the last reported balance sheet, China Travel International Investment Hong Kong had liabilities of HK$2.62b due within 12 months, and liabilities of HK$1.55b due beyond 12 months. Offsetting these obligations, it had cash of HK$3.83b as well as receivables valued at HK$436.4m due within 12 months. So it can boast HK$92.0m more liquid assets than total liabilities.
Having regard to China Travel International Investment Hong Kong's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the HK$6.87b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, China Travel International Investment Hong Kong boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact China Travel International Investment Hong Kong's saving grace is its low debt levels, because its EBIT has tanked 40% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Travel International Investment Hong Kong's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Travel International Investment Hong Kong 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. During the last three years, China Travel International Investment Hong Kong burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While it is always sensible to investigate a company's debt, in this case China Travel International Investment Hong Kong has HK$3.7b in net cash and a decent-looking balance sheet. So while China Travel International Investment Hong Kong does not have a great balance sheet, it's certainly not too bad. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check China Travel International Investment Hong Kong's dividend history, without delay!
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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