Here's Why Sparkle Roll Group (HKG:970) Has A Meaningful Debt Burden

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. We can see that Sparkle Roll Group Limited (HKG:970) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sparkle Roll Group

How Much Debt Does Sparkle Roll Group Carry?

You can click the graphic below for the historical numbers, but it shows that Sparkle Roll Group had HK$473.6m of debt in September 2020, down from HK$746.3m, one year before. However, it does have HK$505.7m in cash offsetting this, leading to net cash of HK$32.1m.

A Look At Sparkle Roll Group's Liabilities

We can see from the most recent balance sheet that Sparkle Roll Group had liabilities of HK$893.3m falling due within a year, and liabilities of HK$531.2m due beyond that. On the other hand, it had cash of HK$505.7m and HK$45.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$873.7m.

This is a mountain of leverage relative to its market capitalization of HK$1.28b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Sparkle Roll Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Sparkle Roll Group's EBIT fell a jaw-dropping 31% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Sparkle Roll Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sparkle Roll Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Sparkle Roll Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although Sparkle Roll Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$32.1m. The cherry on top was that in converted 182% of that EBIT to free cash flow, bringing in HK$437m. So although we see some areas for improvement, we're not too worried about Sparkle Roll Group's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Sparkle Roll Group has 3 warning signs we think you should be aware of.

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. 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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