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. As with many other companies Chinney Alliance Group Limited (HKG:385) makes use of debt. But is this debt a concern to shareholders?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Chinney Alliance Group's Net Debt?
As you can see below, at the end of December 2018, Chinney Alliance Group had HK$167.4m of debt, up from HK$146.1m a year ago. Click the image for more detail. But it also has HK$851.0m in cash to offset that, meaning it has HK$683.6m net cash.
How Strong Is Chinney Alliance Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Chinney Alliance Group had liabilities of HK$1.61b due within 12 months and liabilities of HK$98.7m due beyond that. Offsetting this, it had HK$851.0m in cash and HK$1.85b in receivables that were due within 12 months. So it actually has HK$993.5m more liquid assets than total liabilities.
This luscious liquidity implies that Chinney Alliance Group's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Chinney Alliance Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Chinney Alliance Group grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chinney Alliance Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Chinney Alliance Group 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. Considering the last three years, Chinney Alliance Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for and improvement.
While it is always sensible to investigate a company's debt, in this case Chinney Alliance Group has HK$684m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 13% in the last twelve months. So is Chinney Alliance Group's debt a risk? It doesn't seem so to us. Given Chinney Alliance Group has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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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