Is Sinomax Group (HKG:1418) Weighed On By Its Debt Load?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Sinomax Group Limited (HKG:1418) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sinomax Group

What Is Sinomax Group's Net Debt?

The image below, which you can click on for greater detail, shows that Sinomax Group had debt of HK$488.6m at the end of June 2023, a reduction from HK$669.1m over a year. However, because it has a cash reserve of HK$240.5m, its net debt is less, at about HK$248.1m.

How Strong Is Sinomax Group's Balance Sheet?

We can see from the most recent balance sheet that Sinomax Group had liabilities of HK$1.20b falling due within a year, and liabilities of HK$237.9m due beyond that. Offsetting these obligations, it had cash of HK$240.5m as well as receivables valued at HK$658.7m due within 12 months. So its liabilities total HK$542.9m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$136.5m 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 definitely think shareholders need to watch this one closely. After all, Sinomax Group would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sinomax Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Sinomax Group made a loss at the EBIT level, and saw its revenue drop to HK$3.1b, which is a fall of 20%. We would much prefer see growth.

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. To be specific the EBIT loss came in at HK$419k. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. However, we note that trailing twelve month EBIT is worse than the free cash flow of HK$364m and the profit of HK$25m. So there is arguably potential that the company is going to turn things around. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Sinomax Group (at least 1 which is significant) , and understanding them should be part of your investment process.

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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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.