Would SJM Holdings (HKG:880) Be Better Off With Less Debt?

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. We note that SJM Holdings Limited (HKG:880) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, 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 Debt?

The image below, which you can click on for greater detail, shows that at June 2021 SJM Holdings had debt of HK$18.7b, up from HK$15.5b in one year. However, it does have HK$2.56b in cash offsetting this, leading to net debt of about HK$16.1b.

A Look At SJM Holdings' Liabilities

The latest balance sheet data shows that SJM Holdings had liabilities of HK$15.8b due within a year, and liabilities of HK$10.5b falling due after that. On the other hand, it had cash of HK$2.56b and HK$515.8m worth of receivables due within a year. So it has liabilities totalling HK$23.3b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of HK$36.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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 had a loss before interest and tax, and actually shrunk its revenue by 61%, to HK$8.4b. To be frank that doesn't bode well.

Caveat Emptor

While SJM Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost HK$3.3b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled HK$11b in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. For instance, we've identified 2 warning signs for SJM Holdings (1 is a bit concerning) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.
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