Here's Why China Sinostar Group (HKG:485) Can Afford Some Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that China Sinostar Group Company Limited (HKG:485) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Sinostar Group

What Is China Sinostar Group's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 China Sinostar Group had debt of HK$33.1m, up from HK$31.4m in one year. However, it does have HK$29.5m in cash offsetting this, leading to net debt of about HK$3.62m.

How Healthy Is China Sinostar Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Sinostar Group had liabilities of HK$60.2m due within 12 months and liabilities of HK$11.8m due beyond that. On the other hand, it had cash of HK$29.5m and HK$19.9m worth of receivables due within a year. So it has liabilities totalling HK$22.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because China Sinostar Group is worth HK$46.8m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 China Sinostar 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.

In the last year China Sinostar Group had a loss before interest and tax, and actually shrunk its revenue by 79%, to HK$43m. To be frank that doesn't bode well.

Caveat Emptor

Not only did China Sinostar Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$21m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of HK$24m. So in short it's a really risky stock. 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. Be aware that China Sinostar Group is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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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