Sun Kong Holdings (HKG:8631) Is Making Moderate Use Of 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. Importantly, Sun Kong Holdings Limited (HKG:8631) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Sun Kong Holdings

What Is Sun Kong Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Sun Kong Holdings had HK$12.2m of debt, an increase on HK$10.5m, over one year. However, because it has a cash reserve of HK$1.04m, its net debt is less, at about HK$11.1m.

How Strong Is Sun Kong Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sun Kong Holdings had liabilities of HK$18.3m due within 12 months and no liabilities due beyond that. Offsetting these obligations, it had cash of HK$1.04m as well as receivables valued at HK$45.8m due within 12 months. So it can boast HK$28.6m more liquid assets than total liabilities.

This excess liquidity is a great indication that Sun Kong Holdings' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sun Kong Holdings 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 Sun Kong Holdings had a loss before interest and tax, and actually shrunk its revenue by 71%, to HK$68m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Sun Kong Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable HK$12m at the EBIT level. Having said that, the balance sheet has plenty of liquid assets for now. That should give the business time to grow its cashflow. While the stock is probably a bit risky, there may be an opportunity if the business itself improves, allowing the company to stage a recovery. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Sun Kong Holdings (including 2 which don't sit too well with us) .

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.