These 4 Measures Indicate That Shun Ho Holdings (HKG:253) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shun Ho Holdings Limited (HKG:253) makes use of debt. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shun Ho Holdings

How Much Debt Does Shun Ho Holdings Carry?

As you can see below, Shun Ho Holdings had HK$869.9m of debt at December 2020, down from HK$914.7m a year prior. However, it also had HK$178.5m in cash, and so its net debt is HK$691.4m.

A Look At Shun Ho Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Shun Ho Holdings had liabilities of HK$309.8m due within 12 months and liabilities of HK$833.0m due beyond that. On the other hand, it had cash of HK$178.5m and HK$13.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$951.1m.

This deficit casts a shadow over the HK$224.8m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Shun Ho Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Shun Ho Holdings's debt is 3.6 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shareholders should be aware that Shun Ho Holdings's EBIT was down 45% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shun Ho Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Shun Ho Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Shun Ho Holdings's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, it seems to us that Shun Ho Holdings's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Shun Ho Holdings has 2 warning signs (and 1 which can't be ignored) we think you should know about.

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. 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.
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