We Think SANVO Fine Chemicals Group (HKG:301) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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 can see that SANVO Fine Chemicals Group Limited (HKG:301) does use debt in its business. But is this debt a concern to shareholders?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for SANVO Fine Chemicals Group

How Much Debt Does SANVO Fine Chemicals Group Carry?

The image below, which you can click on for greater detail, shows that at December 2020 SANVO Fine Chemicals Group had debt of CN¥171.9m, up from CN¥124.8m in one year. However, it also had CN¥77.2m in cash, and so its net debt is CN¥94.7m.

How Strong Is SANVO Fine Chemicals Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SANVO Fine Chemicals Group had liabilities of CN¥347.0m due within 12 months and liabilities of CN¥91.4m due beyond that. Offsetting this, it had CN¥77.2m in cash and CN¥134.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥226.6m.

While this might seem like a lot, it is not so bad since SANVO Fine Chemicals Group has a market capitalization of CN¥401.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

SANVO Fine Chemicals Group's net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest expense, being 29.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that SANVO Fine Chemicals Group has boosted its EBIT by 80%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SANVO Fine Chemicals Group 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, SANVO Fine Chemicals Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

SANVO Fine Chemicals Group's interest cover was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about SANVO Fine Chemicals Group's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 3 warning signs for SANVO Fine Chemicals Group you should be aware of.

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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