Here's Why Sheung Moon Holdings (HKG:8523) Can Afford Some Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Sheung Moon Holdings Limited (HKG:8523) makes use of debt. 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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sheung Moon Holdings

What Is Sheung Moon Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Sheung Moon Holdings had HK$118.7m of debt, an increase on HK$97.1m, over one year. On the flip side, it has HK$12.5m in cash leading to net debt of about HK$106.2m.

How Healthy Is Sheung Moon Holdings' Balance Sheet?

The latest balance sheet data shows that Sheung Moon Holdings had liabilities of HK$212.3m due within a year, and liabilities of HK$13.8m falling due after that. On the other hand, it had cash of HK$12.5m and HK$271.1m worth of receivables due within a year. So it can boast HK$57.5m more liquid assets than total liabilities.

This surplus strongly suggests that Sheung Moon Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. There's no doubt that we learn most about debt from the balance sheet. But it is Sheung Moon 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.

In the last year Sheung Moon Holdings had a loss before interest and tax, and actually shrunk its revenue by 40%, to HK$342m. That makes us nervous, to say the least.

Caveat Emptor

While Sheung Moon Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$14m. Having said that, the balance sheet has plenty of liquid assets for now. That should give the business time to grow its cashflow. While the stock is probably a bit risky, there may be an opportunity if the business itself improves, allowing the company to stage a recovery. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Sheung Moon Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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. 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.