SJM Holdings (HKG:880) Has Debt But No Earnings; Should You Worry?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, SJM Holdings Limited (HKG:880) does carry 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SJM Holdings

What Is SJM Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 SJM Holdings had HK$28.9b of debt, an increase on HK$26.3b, over one year. On the flip side, it has HK$3.95b in cash leading to net debt of about HK$24.9b.

How Strong Is SJM Holdings' Balance Sheet?

According to the last reported balance sheet, SJM Holdings had liabilities of HK$5.69b due within 12 months, and liabilities of HK$30.7b due beyond 12 months. Offsetting these obligations, it had cash of HK$3.95b as well as receivables valued at HK$455.5m due within 12 months. So it has liabilities totalling HK$32.0b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's HK$23.0b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SJM Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year SJM Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 33%, to HK$12b. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, SJM Holdings still had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$3.6b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through HK$5.3b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. We've identified 2 warning signs with SJM Holdings (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.