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.' 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. As with many other companies Sun.King Power Electronics Group Limited (HKG:580) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is Sun.King Power Electronics Group's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Sun.King Power Electronics Group had debt of CN¥474.4m, up from CN¥327.2m in one year. But it also has CN¥534.8m in cash to offset that, meaning it has CN¥60.4m net cash.
How Strong Is Sun.King Power Electronics Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sun.King Power Electronics Group had liabilities of CN¥806.2m due within 12 months and liabilities of CN¥20.3m due beyond that. On the other hand, it had cash of CN¥534.8m and CN¥1.04b worth of receivables due within a year. So it actually has CN¥752.8m more liquid assets than total liabilities.
It's good to see that Sun.King Power Electronics Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Sun.King Power Electronics Group boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Sun.King Power Electronics Group has increased its EBIT by 8.3% over twelve months, which should ease any concerns about debt repayment. 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 Sun.King Power Electronics Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sun.King Power Electronics Group 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. In the last three years, Sun.King Power Electronics Group created free cash flow amounting to 2.6% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to investigate a company's debt, in this case Sun.King Power Electronics Group has CN¥60.4m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 8.3% in the last twelve months. So we don't have any problem with Sun.King Power Electronics Group's use of debt. 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. Case in point: We've spotted 3 warning signs for Sun.King Power Electronics Group you should be aware of, and 1 of them is a bit 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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