Health Check: How Prudently Does Sinomax Group (HKG:1418) Use Debt?

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.' 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 Sinomax Group Limited (HKG:1418) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Sinomax Group

What Is Sinomax Group's Debt?

The image below, which you can click on for greater detail, shows that Sinomax Group had debt of HK$616.8m at the end of June 2020, a reduction from HK$786.3m over a year. However, it does have HK$369.2m in cash offsetting this, leading to net debt of about HK$247.6m.

A Look At Sinomax Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Sinomax Group had liabilities of HK$1.21b due within 12 months and liabilities of HK$209.6m due beyond that. Offsetting these obligations, it had cash of HK$369.2m as well as receivables valued at HK$462.2m due within 12 months. So its liabilities total HK$588.4m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$176.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Sinomax Group would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sinomax Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Sinomax Group had a loss before interest and tax, and actually shrunk its revenue by 30%, to HK$2.6b. To be frank that doesn't bode well.

Caveat Emptor

While Sinomax Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$132m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it lost HK$263m in just last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is quite risky. We'd prefer to pass. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Sinomax Group you should be aware of, and 2 of them can't be ignored.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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