Does Sansheng Holdings (Group) (HKG:2183) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Sansheng Holdings (Group) Co. Ltd. (HKG:2183) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sansheng Holdings (Group)

How Much Debt Does Sansheng Holdings (Group) Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Sansheng Holdings (Group) had debt of CN¥20.4b, up from CN¥8.66b in one year. However, because it has a cash reserve of CN¥7.47b, its net debt is less, at about CN¥12.9b.

A Look At Sansheng Holdings (Group)'s Liabilities

Zooming in on the latest balance sheet data, we can see that Sansheng Holdings (Group) had liabilities of CN¥33.9b due within 12 months and liabilities of CN¥16.5b due beyond that. Offsetting these obligations, it had cash of CN¥7.47b as well as receivables valued at CN¥2.92b due within 12 months. So it has liabilities totalling CN¥40.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥2.04b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Sansheng Holdings (Group) would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Strangely Sansheng Holdings (Group) has a sky high EBITDA ratio of 7.7, implying high debt, but a strong interest coverage of 33.0. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Sansheng Holdings (Group) is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 450% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sansheng Holdings (Group) 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sansheng Holdings (Group) saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Sansheng Holdings (Group)'s conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, it seems to us that Sansheng Holdings (Group)'s balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 Sansheng Holdings (Group) (including 1 which is a bit unpleasant) .

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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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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