David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Liu Chong Hing Investment Limited (HKG:194) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Liu Chong Hing Investment's Net Debt?
As you can see below, at the end of June 2019, Liu Chong Hing Investment had HK$1.42b of debt, up from HK$971.2m a year ago. Click the image for more detail. But on the other hand it also has HK$2.24b in cash, leading to a HK$822.3m net cash position.
A Look At Liu Chong Hing Investment's Liabilities
The latest balance sheet data shows that Liu Chong Hing Investment had liabilities of HK$2.07b due within a year, and liabilities of HK$331.2m falling due after that. On the other hand, it had cash of HK$2.24b and HK$55.2m worth of receivables due within a year. So its liabilities total HK$103.4m more than the combination of its cash and short-term receivables.
Of course, Liu Chong Hing Investment has a market capitalization of HK$4.11b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Liu Chong Hing Investment also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Liu Chong Hing Investment grew its EBIT by 20% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Liu Chong Hing Investment's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Liu Chong Hing Investment may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Liu Chong Hing Investment actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We could understand if investors are concerned about Liu Chong Hing Investment's liabilities, but we can be reassured by the fact it has has net cash of HK$822m. The cherry on top was that in converted 144% of that EBIT to free cash flow, bringing in HK$811m. So is Liu Chong Hing Investment's debt a risk? It doesn't seem so to us. We'd be very excited to see if Liu Chong Hing Investment insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.