Shoucheng Holdings (HKG:697) May Not Be Profitable But It Seems To Be Managing Its Debt Just Fine, Anyway

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shoucheng Holdings Limited (HKG:697) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shoucheng Holdings

What Is Shoucheng Holdings's Net Debt?

As you can see below, at the end of December 2020, Shoucheng Holdings had HK$482.9m of debt, up from HK$456.7m a year ago. Click the image for more detail. But it also has HK$4.25b in cash to offset that, meaning it has HK$3.77b net cash.

How Strong Is Shoucheng Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shoucheng Holdings had liabilities of HK$699.9m due within 12 months and liabilities of HK$1.51b due beyond that. On the other hand, it had cash of HK$4.25b and HK$444.0m worth of receivables due within a year. So it actually has HK$2.49b more liquid assets than total liabilities.

This surplus suggests that Shoucheng Holdings is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Shoucheng Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. 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're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Shoucheng Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 78%, to HK$706m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Shoucheng Holdings?

While Shoucheng Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$659m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We think its revenue growth of 78% is a good sign. There's no doubt fast top line growth can cure all manner of ills, for a stock. 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. For instance, we've identified 3 warning signs for Shoucheng Holdings that 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. 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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