Here's Why S.F. Holding (SZSE:002352) Can Manage Its Debt Responsibly

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. Importantly, S.F. Holding Co., Ltd. (SZSE:002352) does carry debt. 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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 S.F. Holding

What Is S.F. Holding's Net Debt?

As you can see below, at the end of March 2024, S.F. Holding had CN¥65.1b of debt, up from CN¥58.6b a year ago. Click the image for more detail. However, it does have CN¥53.5b in cash offsetting this, leading to net debt of about CN¥11.6b.

How Strong Is S.F. Holding's Balance Sheet?

We can see from the most recent balance sheet that S.F. Holding had liabilities of CN¥77.7b falling due within a year, and liabilities of CN¥45.2b due beyond that. On the other hand, it had cash of CN¥53.5b and CN¥30.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥39.0b.

This deficit isn't so bad because S.F. Holding is worth a massive CN¥163.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

S.F. Holding has a low net debt to EBITDA ratio of only 0.60. And its EBIT easily covers its interest expense, being 15.2 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, S.F. Holding saw its EBIT drop by 5.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine S.F. Holding's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, S.F. Holding actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

S.F. Holding's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Taking all this data into account, it seems to us that S.F. Holding takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with S.F. Holding .

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.

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.