Stock Analysis

These 4 Measures Indicate That Suga International Holdings (HKG:912) Is Using Debt Reasonably Well

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SEHK:912
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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Suga International Holdings Limited (HKG:912) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Suga International Holdings

What Is Suga International Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Suga International Holdings had HK$100.2m of debt, an increase on HK$89.2m, over one year. But on the other hand it also has HK$137.2m in cash, leading to a HK$37.0m net cash position.

debt-equity-history-analysis
SEHK:912 Debt to Equity History December 24th 2020

How Strong Is Suga International Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Suga International Holdings had liabilities of HK$452.7m due within 12 months and liabilities of HK$4.24m due beyond that. Offsetting this, it had HK$137.2m in cash and HK$389.7m in receivables that were due within 12 months. So it actually has HK$70.0m more liquid assets than total liabilities.

This excess liquidity suggests that Suga International Holdings is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Suga International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Suga International Holdings saw its EBIT decline by 6.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Suga International Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Suga International Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Suga International Holdings's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Suga International Holdings has HK$37.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Suga International Holdings's use of debt. 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 Suga International Holdings is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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