Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Zhong An Group Limited (HKG:672) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhong An Group

How Much Debt Does Zhong An Group Carry?

As you can see below, at the end of June 2019, Zhong An Group had CN¥5.83b of debt, up from CN¥5.33b a year ago. Click the image for more detail. However, it does have CN¥2.05b in cash offsetting this, leading to net debt of about CN¥3.78b.

A Look At Zhong An Group's Liabilities

The latest balance sheet data shows that Zhong An Group had liabilities of CN¥10.3b due within a year, and liabilities of CN¥6.27b falling due after that. Offsetting this, it had CN¥2.05b in cash and CN¥301.7m in receivables that were due within 12 months. So it has liabilities totalling CN¥14.2b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥1.33b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Zhong An Group would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.