SMIT Holdings (HKG:2239) Is Making Moderate Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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?

Why Does Debt Bring Risk?

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 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. 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.

View our latest analysis for SMIT Holdings

What Is SMIT Holdings's Net Debt?

As you can see below, SMIT Holdings had US$28.4m of debt at December 2021, down from US$38.1m a year prior. However, it also had US$18.8m in cash, and so its net debt is US$9.59m.

How Healthy Is SMIT Holdings' Balance Sheet?

We can see from the most recent balance sheet that SMIT Holdings had liabilities of US$40.1m falling due within a year, and liabilities of US$53.5m due beyond that. On the other hand, it had cash of US$18.8m and US$27.8m worth of receivables due within a year. So it has liabilities totalling US$47.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because SMIT Holdings is worth US$81.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SMIT Holdings will need earnings to service that debt. 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.

Over 12 months, SMIT Holdings made a loss at the EBIT level, and saw its revenue drop to US$36m, which is a fall of 4.1%. That's not what we would hope to see.

Caveat Emptor

Importantly, SMIT Holdings had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at US$4.7m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$9.0m of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with SMIT Holdings (including 1 which doesn't sit too well with us) .

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. 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.