Is SUNeVision Holdings (HKG:1686) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 SUNeVision Holdings Ltd. (HKG:1686) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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.

Check out our latest analysis for SUNeVision Holdings

How Much Debt Does SUNeVision Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 SUNeVision Holdings had HK$10.5b of debt, an increase on HK$9.13b, over one year. On the flip side, it has HK$303.2m in cash leading to net debt of about HK$10.2b.

How Strong Is SUNeVision Holdings' Balance Sheet?

The latest balance sheet data shows that SUNeVision Holdings had liabilities of HK$1.20b due within a year, and liabilities of HK$10.8b falling due after that. On the other hand, it had cash of HK$303.2m and HK$396.7m worth of receivables due within a year. So its liabilities total HK$11.3b more than the combination of its cash and short-term receivables.

SUNeVision Holdings has a market capitalization of HK$31.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

As it happens SUNeVision Holdings has a fairly concerning net debt to EBITDA ratio of 9.2 but very strong interest coverage of 173. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. If SUNeVision Holdings can keep growing EBIT at last year's rate of 16% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SUNeVision Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, SUNeVision Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Neither SUNeVision Holdings's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that SUNeVision Holdings is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with SUNeVision Holdings (including 1 which shouldn't be ignored) .

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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