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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Zhong Ao Home Group Limited (HKG:1538) does use debt in its business. But is this debt a concern to shareholders?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Zhong Ao Home Group
How Much Debt Does Zhong Ao Home Group Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Zhong Ao Home Group had CN¥167.6m of debt, an increase on CN¥99.7m, over one year. However, its balance sheet shows it holds CN¥418.4m in cash, so it actually has CN¥250.8m net cash.
How Strong Is Zhong Ao Home Group's Balance Sheet?
The latest balance sheet data shows that Zhong Ao Home Group had liabilities of CN¥1.00b due within a year, and liabilities of CN¥153.1m falling due after that. Offsetting these obligations, it had cash of CN¥418.4m as well as receivables valued at CN¥488.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥247.0m.
While this might seem like a lot, it is not so bad since Zhong Ao Home Group has a market capitalization of CN¥503.0m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Zhong Ao Home Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Zhong Ao Home Group saw its EBIT drop by 6.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Zhong Ao Home Group'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.