Sitoy Group Holdings (HKG:1023) Seems To Use Debt Rather Sparingly
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. We note that Sitoy Group Holdings Limited (HKG:1023) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
Check out our latest analysis for Sitoy Group Holdings
What Is Sitoy Group Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that at December 2019 Sitoy Group Holdings had debt of HK$168.8m, up from HK$80.2m in one year. But it also has HK$504.2m in cash to offset that, meaning it has HK$335.4m net cash.
How Strong Is Sitoy Group Holdings's Balance Sheet?
We can see from the most recent balance sheet that Sitoy Group Holdings had liabilities of HK$597.9m falling due within a year, and liabilities of HK$97.5m due beyond that. Offsetting this, it had HK$504.2m in cash and HK$401.7m in receivables that were due within 12 months. So it actually has HK$210.5m more liquid assets than total liabilities.
This surplus strongly suggests that Sitoy Group Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Succinctly put, Sitoy Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Sitoy Group Holdings's load is not too heavy, because its EBIT was down 71% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sitoy Group Holdings will need earnings to service that debt. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sitoy Group Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Sitoy Group Holdings recorded free cash flow worth a fulsome 81% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Sitoy Group Holdings has HK$335.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$214m, being 81% of its EBIT. So is Sitoy Group Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Sitoy Group Holdings has 5 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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. 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. Thank you for reading.
