Health Check: How Prudently Does Strong Petrochemical Holdings (HKG:852) Use Debt?

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.' 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 Strong Petrochemical Holdings Limited (HKG:852) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Strong Petrochemical Holdings

What Is Strong Petrochemical Holdings's Debt?

The image below, which you can click on for greater detail, shows that Strong Petrochemical Holdings had debt of HK$140.2m at the end of December 2020, a reduction from HK$1.01b over a year. But on the other hand it also has HK$145.4m in cash, leading to a HK$5.21m net cash position.

How Healthy Is Strong Petrochemical Holdings' Balance Sheet?

According to the last reported balance sheet, Strong Petrochemical Holdings had liabilities of HK$325.8m due within 12 months, and liabilities of HK$496.0k due beyond 12 months. Offsetting these obligations, it had cash of HK$145.4m as well as receivables valued at HK$806.1m due within 12 months. So it actually has HK$625.2m more liquid assets than total liabilities.

This luscious liquidity implies that Strong Petrochemical Holdings' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Strong Petrochemical Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Strong Petrochemical Holdings's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Strong Petrochemical Holdings made a loss at the EBIT level, and saw its revenue drop to HK$6.6b, which is a fall of 62%. To be frank that doesn't bode well.

So How Risky Is Strong Petrochemical Holdings?

Although Strong Petrochemical Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of HK$692m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. There's no doubt the next few years will be crucial to how the business matures. 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. To that end, you should learn about the 2 warning signs we've spotted with Strong Petrochemical Holdings (including 1 which can't be ignored) .

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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