Here's Why Sinotruk (Hong Kong) (HKG:3808) Can Manage Its Debt Responsibly

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 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. As with many other companies Sinotruk (Hong Kong) Limited (HKG:3808) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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. 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 Sinotruk (Hong Kong)

How Much Debt Does Sinotruk (Hong Kong) Carry?

The image below, which you can click on for greater detail, shows that Sinotruk (Hong Kong) had debt of CN¥4.24b at the end of June 2023, a reduction from CN¥4.88b over a year. However, it does have CN¥26.2b in cash offsetting this, leading to net cash of CN¥22.0b.

A Look At Sinotruk (Hong Kong)'s Liabilities

According to the last reported balance sheet, Sinotruk (Hong Kong) had liabilities of CN¥66.4b due within 12 months, and liabilities of CN¥1.22b due beyond 12 months. Offsetting this, it had CN¥26.2b in cash and CN¥15.5b in receivables that were due within 12 months. So its liabilities total CN¥25.8b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥39.1b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Sinotruk (Hong Kong) boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Sinotruk (Hong Kong) grew its EBIT by 104% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinotruk (Hong Kong)'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sinotruk (Hong Kong) 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. During the last three years, Sinotruk (Hong Kong) produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Sinotruk (Hong Kong) does have more liabilities than liquid assets, it also has net cash of CN¥22.0b. And it impressed us with its EBIT growth of 104% over the last year. So we don't have any problem with Sinotruk (Hong Kong)'s use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Sinotruk (Hong Kong)'s earnings per share history for free.

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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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.