Is SMIT Holdings (HKG:2239) Using Too Much 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 can see that SMIT Holdings Limited (HKG:2239) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for SMIT Holdings

What Is SMIT Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 SMIT Holdings had debt of US$38.1m, up from none in one year. However, it does have US$46.5m in cash offsetting this, leading to net cash of US$8.33m.

How Strong Is SMIT Holdings' Balance Sheet?

The latest balance sheet data shows that SMIT Holdings had liabilities of US$61.8m due within a year, and liabilities of US$44.4m falling due after that. Offsetting these obligations, it had cash of US$46.5m as well as receivables valued at US$38.9m due within 12 months. So its liabilities total US$20.8m more than the combination of its cash and short-term receivables.

Of course, SMIT Holdings has a market capitalization of US$135.7m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is SMIT Holdings'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 SMIT Holdings's revenue was pretty flat, and it made a negative EBIT. While that hardly impresses, its not too bad either.

So How Risky Is SMIT Holdings?

Although SMIT Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$6.2m. 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. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for SMIT Holdings you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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