Sinomax Group (HKG:1418) Has Debt But No Earnings; Should You Worry?

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.' 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. We note that Sinomax Group Limited (HKG:1418) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out the opportunities and risks within the HK Consumer Durables industry.

What Is Sinomax Group's Net Debt?

As you can see below, at the end of June 2022, Sinomax Group had HK$669.1m of debt, up from HK$603.9m a year ago. Click the image for more detail. However, it does have HK$213.0m in cash offsetting this, leading to net debt of about HK$456.1m.

How Healthy Is Sinomax Group's Balance Sheet?

According to the last reported balance sheet, Sinomax Group had liabilities of HK$1.35b due within 12 months, and liabilities of HK$273.1m due beyond 12 months. Offsetting this, it had HK$213.0m in cash and HK$618.1m in receivables that were due within 12 months. So it has liabilities totalling HK$789.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$162.8m 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 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. There's no doubt that we learn most about debt from the balance sheet. 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 6.3%, to HK$3.9b. That's not what we would hope to see.

Caveat Emptor

Importantly, Sinomax Group had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$74m. 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. But we think that is unlikely since it is low on liquid assets, and made a loss of HK$36m in the last year. So we think this stock is quite risky. We'd prefer to pass. 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. Be aware that Sinomax Group is showing 5 warning signs in our investment analysis , and 2 of those make us uncomfortable...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.