Health Check: How Prudently Does SIM Technology Group (HKG:2000) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that SIM Technology Group Limited (HKG:2000) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SIM Technology Group

How Much Debt Does SIM Technology Group Carry?

You can click the graphic below for the historical numbers, but it shows that SIM Technology Group had HK$36.0m of debt in December 2020, down from HK$77.9m, one year before. However, it does have HK$963.3m in cash offsetting this, leading to net cash of HK$927.3m.

A Look At SIM Technology Group's Liabilities

According to the last reported balance sheet, SIM Technology Group had liabilities of HK$448.1m due within 12 months, and liabilities of HK$205.7m due beyond 12 months. Offsetting this, it had HK$963.3m in cash and HK$331.4m in receivables that were due within 12 months. So it can boast HK$641.0m more liquid assets than total liabilities.

This excess liquidity is a great indication that SIM Technology Group's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that SIM Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SIM Technology 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.

In the last year SIM Technology Group had a loss before interest and tax, and actually shrunk its revenue by 19%, to HK$938m. We would much prefer see growth.

So How Risky Is SIM Technology Group?

While SIM Technology Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow HK$94m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. The next few years will be important as the business matures. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for SIM Technology Group that you should be aware of.

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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