We Think Shoucheng Holdings (HKG:697) Is Taking Some Risk With Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shoucheng Holdings Limited (HKG:697) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shoucheng Holdings

How Much Debt Does Shoucheng Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Shoucheng Holdings had HK$1.24b of debt, an increase on HK$1.07b, over one year. But it also has HK$4.93b in cash to offset that, meaning it has HK$3.70b net cash.

A Look At Shoucheng Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Shoucheng Holdings had liabilities of HK$1.80b due within 12 months and liabilities of HK$2.43b due beyond that. On the other hand, it had cash of HK$4.93b and HK$303.9m worth of receivables due within a year. So it can boast HK$1.02b more liquid assets than total liabilities.

This short term liquidity is a sign that Shoucheng Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shoucheng Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shoucheng Holdings's saving grace is its low debt levels, because its EBIT has tanked 62% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shoucheng Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shoucheng Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Shoucheng Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shoucheng Holdings has net cash of HK$3.70b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Shoucheng Holdings's balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shoucheng Holdings (of which 1 doesn't sit too well with us!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.