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Health Check: How Prudently Does Chuang's China Investments (HKG:298) Use Debt?

Simply Wall St

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Chuang's China Investments Limited (HKG:298) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Chuang's China Investments

What Is Chuang's China Investments's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2019 Chuang's China Investments had debt of HK$2.11b, up from HK$1.66b in one year. However, it also had HK$1.60b in cash, and so its net debt is HK$507.0m.

SEHK:298 Historical Debt, August 14th 2019

How Strong Is Chuang's China Investments's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chuang's China Investments had liabilities of HK$1.87b due within 12 months and liabilities of HK$1.52b due beyond that. Offsetting this, it had HK$1.60b in cash and HK$57.7m in receivables that were due within 12 months. So it has liabilities totalling HK$1.73b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$1.09b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Chuang's China Investments would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chuang's China Investments's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Chuang's China Investments reported revenue of HK$200m, which is a gain of 15%. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Chuang's China Investments produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$61m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. But on the bright side the company actually produced a statutory profit of HK$168m and free cash flow of HK$13m. So one might argue that there's still a chance it can get things on the right track. For riskier companies like Chuang's China Investments I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.