We Think Come Sure Group (Holdings) (HKG:794) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Come Sure Group (Holdings) Limited (HKG:794) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Come Sure Group (Holdings)

What Is Come Sure Group (Holdings)'s Debt?

The chart below, which you can click on for greater detail, shows that Come Sure Group (Holdings) had HK$307.4m in debt in September 2020; about the same as the year before. However, because it has a cash reserve of HK$219.5m, its net debt is less, at about HK$87.9m.

How Healthy Is Come Sure Group (Holdings)'s Balance Sheet?

We can see from the most recent balance sheet that Come Sure Group (Holdings) had liabilities of HK$602.0m falling due within a year, and liabilities of HK$203.9m due beyond that. On the other hand, it had cash of HK$219.5m and HK$283.9m worth of receivables due within a year. So it has liabilities totalling HK$302.4m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the HK$199.4m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Come Sure Group (Holdings) would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Come Sure Group (Holdings)'s low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.1 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Sadly, Come Sure Group (Holdings)'s EBIT actually dropped 8.1% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Come Sure Group (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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Come Sure Group (Holdings) recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Mulling over Come Sure Group (Holdings)'s attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Come Sure Group (Holdings)'s debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Come Sure Group (Holdings) , and understanding them should be part of your investment process.

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. 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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