Here's Why Sinofert Holdings (HKG:297) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Sinofert Holdings Limited (HKG:297) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for Sinofert Holdings

What Is Sinofert Holdings's Debt?

The image below, which you can click on for greater detail, shows that Sinofert Holdings had debt of CN¥1.04b at the end of December 2021, a reduction from CN¥1.71b over a year. But on the other hand it also has CN¥1.32b in cash, leading to a CN¥275.4m net cash position.

How Strong Is Sinofert Holdings' Balance Sheet?

The latest balance sheet data shows that Sinofert Holdings had liabilities of CN¥7.16b due within a year, and liabilities of CN¥1.35b falling due after that. On the other hand, it had cash of CN¥1.32b and CN¥3.29b worth of receivables due within a year. So its liabilities total CN¥3.90b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sinofert Holdings is worth CN¥7.93b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Sinofert Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Sinofert Holdings grew its EBIT by 4.1% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sinofert Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sinofert Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Sinofert Holdings recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Sinofert Holdings does have more liabilities than liquid assets, it also has net cash of CN¥275.4m. So we don't have any problem with Sinofert Holdings's use of debt. 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 example - Sinofert Holdings has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.