Is Simplicity Holding (HKG:8367) Weighed On By Its Debt Load?

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 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 Simplicity Holding Limited (HKG:8367) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Simplicity Holding

What Is Simplicity Holding's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Simplicity Holding had debt of HK$18.7m, up from none in one year. However, it does have HK$29.3m in cash offsetting this, leading to net cash of HK$10.6m.

How Healthy Is Simplicity Holding's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Simplicity Holding had liabilities of HK$41.4m due within 12 months and liabilities of HK$12.3m due beyond that. Offsetting this, it had HK$29.3m in cash and HK$910.0k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$23.4m.

Since publicly traded Simplicity Holding shares are worth a total of HK$130.6m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Simplicity Holding also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Simplicity Holding 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 Simplicity Holding had a loss before interest and tax, and actually shrunk its revenue by 44%, to HK$56m. To be frank that doesn't bode well.

So How Risky Is Simplicity Holding?

While Simplicity Holding lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$2.8m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Simplicity Holding that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.