Sundart Holdings (HKG:1568) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Sundart Holdings Limited (HKG:1568) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sundart Holdings

What Is Sundart Holdings's Net Debt?

As you can see below, Sundart Holdings had HK$249.5m of debt at June 2020, down from HK$444.7m a year prior. However, its balance sheet shows it holds HK$609.8m in cash, so it actually has HK$360.3m net cash.

How Healthy Is Sundart Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sundart Holdings had liabilities of HK$2.55b due within 12 months and liabilities of HK$11.6m due beyond that. Offsetting this, it had HK$609.8m in cash and HK$3.31b in receivables that were due within 12 months. So it actually has HK$1.35b more liquid assets than total liabilities.

This excess liquidity suggests that Sundart Holdings is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Sundart Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Sundart Holdings grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sundart Holdings's ability to maintain a healthy balance sheet going forward. 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. While Sundart Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Sundart Holdings's free cash flow amounted to 45% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sundart Holdings has net cash of HK$360.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 51% over the last year. So we don't think Sundart Holdings's use of debt is risky. 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 1 warning sign for Sundart Holdings you should be aware of.

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.

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