Does Sun Art Retail Group (HKG:6808) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Sun Art Retail Group Limited (HKG:6808) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Sun Art Retail Group

What Is Sun Art Retail Group's Net Debt?

As you can see below, at the end of March 2023, Sun Art Retail Group had CN¥673.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥19.2b in cash, leading to a CN¥18.5b net cash position.

How Healthy Is Sun Art Retail Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sun Art Retail Group had liabilities of CN¥34.0b due within 12 months and liabilities of CN¥5.94b due beyond that. Offsetting this, it had CN¥19.2b in cash and CN¥3.06b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥17.7b.

This deficit is considerable relative to its market capitalization of CN¥20.5b, so it does suggest shareholders should keep an eye on Sun Art Retail Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Sun Art Retail Group boasts net cash, so it's fair to say it does not have a heavy debt load!

While Sun Art Retail Group doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sun Art Retail Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sun Art Retail Group 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. Happily for any shareholders, Sun Art Retail Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Sun Art Retail Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥18.5b. The cherry on top was that in converted 277% of that EBIT to free cash flow, bringing in CN¥4.3b. So we don't have any problem with Sun Art Retail Group's use of debt. 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. For example - Sun Art Retail Group has 2 warning signs we think you should be aware of.

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.