Is Sincere Watch (Hong Kong) (HKG:444) Weighed On By Its Debt Load?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Sincere Watch (Hong Kong) Limited (HKG:444) does carry debt. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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?

As you can see below, at the end of March 2022, Sincere Watch (Hong Kong) had HK$295.1m of debt, up from HK$266.0m a year ago. Click the image for more detail. However, because it has a cash reserve of HK$91.2m, its net debt is less, at about HK$203.9m.

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

According to the last reported balance sheet, Sincere Watch (Hong Kong) had liabilities of HK$170.2m due within 12 months, and liabilities of HK$301.1m due beyond 12 months. Offsetting these obligations, it had cash of HK$91.2m as well as receivables valued at HK$40.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$340.2m.

When you consider that this deficiency exceeds the company's HK$241.8m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sincere Watch (Hong Kong)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Sincere Watch (Hong Kong) wasn't profitable at an EBIT level, but managed to grow its revenue by 9.1%, to HK$149m. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Sincere Watch (Hong Kong) produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$50m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$157m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sincere Watch (Hong Kong) (of which 1 doesn't sit too well with us!) you should know about.

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.