Health Check: How Prudently Does Sprocomm Intelligence (HKG:1401) Use Debt?

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.' 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. We note that Sprocomm Intelligence Limited (HKG:1401) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sprocomm Intelligence

What Is Sprocomm Intelligence's Net Debt?

As you can see below, Sprocomm Intelligence had CN¥81.1m of debt at June 2022, down from CN¥106.8m a year prior. But on the other hand it also has CN¥85.4m in cash, leading to a CN¥4.36m net cash position.

How Healthy Is Sprocomm Intelligence's Balance Sheet?

We can see from the most recent balance sheet that Sprocomm Intelligence had liabilities of CN¥1.11b falling due within a year, and liabilities of CN¥46.8m due beyond that. Offsetting these obligations, it had cash of CN¥85.4m as well as receivables valued at CN¥293.3m due within 12 months. So it has liabilities totalling CN¥775.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥510.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Sprocomm Intelligence would likely require a major re-capitalisation if it had to pay its creditors today. Given that Sprocomm Intelligence has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sprocomm Intelligence'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.

In the last year Sprocomm Intelligence had a loss before interest and tax, and actually shrunk its revenue by 11%, to CN¥2.0b. We would much prefer see growth.

So How Risky Is Sprocomm Intelligence?

Although Sprocomm Intelligence had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥24m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We're not impressed by its revenue growth, so until we see some positive sustainable EBIT, we consider the stock to be high risk. 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. For example Sprocomm Intelligence has 4 warning signs (and 1 which is potentially serious) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.