We Think Sheung Yue Group Holdings (HKG:1633) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sheung Yue Group Holdings Limited (HKG:1633) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Sheung Yue Group Holdings

How Much Debt Does Sheung Yue Group Holdings Carry?

As you can see below, Sheung Yue Group Holdings had HK$77.9m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of HK$19.9m, its net debt is less, at about HK$58.0m.

A Look At Sheung Yue Group Holdings' Liabilities

According to the last reported balance sheet, Sheung Yue Group Holdings had liabilities of HK$131.3m due within 12 months, and liabilities of HK$2.75m due beyond 12 months. Offsetting this, it had HK$19.9m in cash and HK$115.7m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This surplus suggests that Sheung Yue Group Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sheung Yue Group Holdings has net debt worth 1.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.8 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Importantly, Sheung Yue Group Holdings grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sheung Yue Group Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Sheung Yue Group Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Sheung Yue Group Holdings's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. Considering this range of data points, we think Sheung Yue Group Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. For example Sheung Yue Group Holdings has 3 warning signs (and 1 which doesn't sit too well with us) 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. 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.