Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. We note that China Asia Valley Group Limited (HKG: 63) has debt on its balance sheet. But the most important question is: what risk does this debt create?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest analysis for China Asia Valley Group
What is the net debt of the China Asia Valley group?
As you can see below, China Asia Valley Group owed HK $ 223.0 million in debt, as of June 2021, which is roughly the same as the year before. You can click on the graph for more details. However, he also had HK $ 5.50 million in cash, so his net debt is HK $ 217.5 million.
How healthy is the China Asia Valley group’s balance sheet?
The latest balance sheet data shows that China Asia Valley Group had debts of HK $ 246.5 million due within one year, and debts of HK $ 732.0,000 due thereafter. In return, he had HK $ 5.50 million in cash and HK $ 5.15 million in receivables due within 12 months. Its liabilities therefore total HK $ 236.6 million more than the combination of its cash and short-term receivables.
This shortfall is sizable compared to its market capitalization of HK $ 281.9 million, so he suggests shareholders keep an eye on China Asia Valley Group’s use of debt. If its lenders asked it to consolidate the balance sheet, shareholders would likely face serious dilution. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since China Asia Valley Group will need profits to repay this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Last year, China Asia Valley Group was not profitable on EBIT level, but managed to increase its turnover by 101%, to HK $ 28 million. Its fairly obvious shareholders are therefore hoping for more growth!
Emptor Warning
Even though China Asia Valley Group has managed to grow its revenue quite adroitly, the hard truth is that it is losing money on the EBIT line. Indeed, it lost 1.7 million Hong Kong dollars in EBIT. When we look at this and recall the liabilities on its balance sheet, versus the cash flow, it seems unwise to us that the company has debt. We therefore believe that its record is a bit strained, but not irreparable. For example, we wouldn’t want to see a repeat of last year’s HK $ 16 million loss. So, to be frank, we think it’s risky. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example – China Asia Valley Group has 2 warning signs we think you should be aware.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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