Here's Why SDM Group Holdings (HKG:8363) Can Afford Some Debt
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 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 SDM Group Holdings Limited (HKG:8363) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for SDM Group Holdings
How Much Debt Does SDM Group Holdings Carry?
As you can see below, at the end of June 2019, SDM Group Holdings had HK$267.3m of debt, up from HK$1.86m a year ago. Click the image for more detail. However, it also had HK$218.6m in cash, and so its net debt is HK$48.8m.
How Strong Is SDM Group Holdings's Balance Sheet?
The latest balance sheet data shows that SDM Group Holdings had liabilities of HK$106.7m due within a year, and liabilities of HK$348.6m falling due after that. Offsetting this, it had HK$218.6m in cash and HK$46.9m in receivables that were due within 12 months. So its liabilities total HK$189.9m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of HK$276.2m. This suggests shareholders would heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SDM Group Holdings'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.
In the last year SDM Group Holdings managed to grow its revenue by 51%, to HK$109m. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
While we can certainly savour SDM Group Holdings's tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. Its EBIT loss was a whopping HK$40m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$42m in negative free cash flow over the last twelve months. So in short it's a really risky stock. For riskier companies like SDM Group Holdings I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
