Does SFK Construction Holdings (HKG:1447) Have A Healthy Balance Sheet?

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.' 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 SFK Construction Holdings Limited (HKG:1447) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SFK Construction Holdings

What Is SFK Construction Holdings's Debt?

As you can see below, SFK Construction Holdings had HK$343.0m of debt at June 2020, down from HK$369.0m a year prior. On the flip side, it has HK$262.3m in cash leading to net debt of about HK$80.7m.

How Healthy Is SFK Construction Holdings's Balance Sheet?

According to the last reported balance sheet, SFK Construction Holdings had liabilities of HK$1.40b due within 12 months, and liabilities of HK$48.3m due beyond 12 months. Offsetting this, it had HK$262.3m in cash and HK$1.41b in receivables that were due within 12 months. So it actually has HK$231.7m more liquid assets than total liabilities.

This excess liquidity is a great indication that SFK Construction Holdings's balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SFK Construction 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.

Over 12 months, SFK Construction Holdings made a loss at the EBIT level, and saw its revenue drop to HK$4.3b, which is a fall of 30%. To be frank that doesn't bode well.

Caveat Emptor

Not only did SFK Construction Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$61m at the EBIT level. That said, we're impressed with the strong balance sheet liquidity. That should give the business time to grow its cashflow. The company is risky because it will grow into the future to get to profitability and free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SFK Construction Holdings is showing 5 warning signs in our investment analysis , and 1 of those is concerning...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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