Is Sincere Watch (Hong Kong) (HKG:444) A Risky Investment?

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.' 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. Importantly, Sincere Watch (Hong Kong) Limited (HKG:444) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sincere Watch (Hong Kong)

How Much Debt Does Sincere Watch (Hong Kong) Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Sincere Watch (Hong Kong) had debt of HK$302.2m, up from HK$192.0m in one year. However, it does have HK$130.0m in cash offsetting this, leading to net debt of about HK$172.2m.

How Strong Is Sincere Watch (Hong Kong)'s Balance Sheet?

According to the last reported balance sheet, Sincere Watch (Hong Kong) had liabilities of HK$250.7m due within 12 months, and liabilities of HK$221.4m due beyond 12 months. Offsetting this, it had HK$130.0m in cash and HK$39.8m in receivables that were due within 12 months. So its liabilities total HK$302.3m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of HK$314.3m, so it does suggest shareholders should keep an eye on Sincere Watch (Hong Kong)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sincere Watch (Hong Kong)'s earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Sincere Watch (Hong Kong) saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Sincere Watch (Hong Kong) had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable HK$65m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$26m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sincere Watch (Hong Kong) is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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. 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.