Is SMIT Holdings (HKG:2239) Using Debt In A Risky Way?

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 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 can see that SMIT Holdings Limited (HKG:2239) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for SMIT Holdings

How Much Debt Does SMIT Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2021 SMIT Holdings had debt of US$30.2m, up from US$6.41m in one year. But on the other hand it also has US$44.3m in cash, leading to a US$14.1m net cash position.

A Look At SMIT Holdings' Liabilities

The latest balance sheet data shows that SMIT Holdings had liabilities of US$60.5m due within a year, and liabilities of US$45.3m falling due after that. Offsetting these obligations, it had cash of US$44.3m as well as receivables valued at US$30.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$31.4m.

Since publicly traded SMIT Holdings shares are worth a total of US$206.1m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, SMIT Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SMIT Holdings'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 SMIT Holdings had a loss before interest and tax, and actually shrunk its revenue by 9.3%, to US$35m. That's not what we would hope to see.

So How Risky Is SMIT Holdings?

While SMIT Holdings lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of US$818k. So taking that on face value, and considering the cash, we don't think its very risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for SMIT Holdings (of which 2 are concerning!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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