Sinotruk (Hong Kong) (HKG:3808) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Sinotruk (Hong Kong) Limited (HKG:3808) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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)

What Is Sinotruk (Hong Kong)'s Net Debt?

As you can see below, at the end of December 2022, Sinotruk (Hong Kong) had CN¥3.89b of debt, up from CN¥3.51b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥31.7b in cash, so it actually has CN¥27.8b net cash.

How Healthy Is Sinotruk (Hong Kong)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sinotruk (Hong Kong) had liabilities of CN¥61.3b due within 12 months and liabilities of CN¥1.20b due beyond that. Offsetting these obligations, it had cash of CN¥31.7b as well as receivables valued at CN¥16.1b due within 12 months. So it has liabilities totalling CN¥14.7b more than its cash and near-term receivables, combined.

Sinotruk (Hong Kong) has a market capitalization of CN¥29.0b, so it could very likely raise cash to ameliorate 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. While it does have liabilities worth noting, Sinotruk (Hong Kong) also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Sinotruk (Hong Kong)'s saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sinotruk (Hong Kong) can strengthen its balance sheet over time. 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. While Sinotruk (Hong Kong) has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Sinotruk (Hong Kong) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Sinotruk (Hong Kong)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥27.8b. The cherry on top was that in converted 123% of that EBIT to free cash flow, bringing in CN¥9.4b. So we don't have any problem with Sinotruk (Hong Kong)'s use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Sinotruk (Hong Kong) has 2 warning signs we think you should be aware of.

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.