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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Citychamp Watch & Jewellery Group Limited (HKG:256) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Citychamp Watch & Jewellery Group
What Is Citychamp Watch & Jewellery Group's Net Debt?
As you can see below, at the end of June 2019, Citychamp Watch & Jewellery Group had HK$1.82b of debt, up from HK$1.13b a year ago. Click the image for more detail. But on the other hand it also has HK$7.12b in cash, leading to a HK$5.30b net cash position.
How Healthy Is Citychamp Watch & Jewellery Group's Balance Sheet?
We can see from the most recent balance sheet that Citychamp Watch & Jewellery Group had liabilities of HK$2.17b falling due within a year, and liabilities of HK$12.7b due beyond that. On the other hand, it had cash of HK$7.12b and HK$5.90b worth of receivables due within a year. So it has liabilities totalling HK$1.90b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Citychamp Watch & Jewellery Group has a market capitalization of HK$7.44b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Citychamp Watch & Jewellery Group boasts net cash, so it's fair to say it does not have a heavy debt load!
We saw Citychamp Watch & Jewellery Group grow its EBIT by 2.9% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Citychamp Watch & Jewellery Group'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.