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

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Strong Petrochemical Holdings Limited (HKG:852) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Strong Petrochemical Holdings

What Is Strong Petrochemical Holdings's Debt?

As you can see below, at the end of June 2023, Strong Petrochemical Holdings had HK$53.3m of debt, up from none a year ago. Click the image for more detail. But it also has HK$331.0m in cash to offset that, meaning it has HK$277.6m net cash.

A Look At Strong Petrochemical Holdings' Liabilities

According to the last reported balance sheet, Strong Petrochemical Holdings had liabilities of HK$56.5m due within 12 months, and liabilities of HK$54.1m due beyond 12 months. Offsetting this, it had HK$331.0m in cash and HK$236.9m in receivables that were due within 12 months. So it actually has HK$457.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Strong Petrochemical Holdings' balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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 you can't view debt in total isolation; since Strong Petrochemical 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.

In the last year Strong Petrochemical Holdings's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

So How Risky Is Strong Petrochemical Holdings?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Strong Petrochemical Holdings had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of HK$13m and booked a HK$18m accounting loss. Given it only has net cash of HK$277.6m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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 Strong Petrochemical Holdings has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.