Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 CSG Holding Co., Ltd. (SZSE:200012) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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.

View our latest analysis for CSG Holding

What Is CSG Holding's Debt?

As you can see below, at the end of March 2023, CSG Holding had CN¥6.28b of debt, up from CN¥4.54b a year ago. Click the image for more detail. However, it does have CN¥2.21b in cash offsetting this, leading to net debt of about CN¥4.07b.

A Look At CSG Holding's Liabilities

The latest balance sheet data shows that CSG Holding had liabilities of CN¥6.04b due within a year, and liabilities of CN¥5.83b falling due after that. Offsetting these obligations, it had cash of CN¥2.21b as well as receivables valued at CN¥3.34b due within 12 months. So its liabilities total CN¥6.32b more than the combination of its cash and short-term receivables.

CSG Holding has a market capitalization of CN¥14.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

CSG Holding has a low net debt to EBITDA ratio of only 1.2. And its EBIT covers its interest expense a whopping 18.6 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that CSG Holding has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CSG Holding can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, CSG Holding created free cash flow amounting to 15% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

CSG Holding's EBIT growth rate and conversion of EBIT to free cash flow definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think CSG Holding's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with CSG Holding (including 1 which is a bit concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.