Is Sinotrans (HKG:598) A Risky Investment?

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.' 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. As with many other companies Sinotrans Limited (HKG:598) makes use of debt. But is this debt a concern to shareholders?

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 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sinotrans

How Much Debt Does Sinotrans Carry?

You can click the graphic below for the historical numbers, but it shows that Sinotrans had CN¥13.0b of debt in June 2022, down from CN¥14.1b, one year before. However, it does have CN¥13.7b in cash offsetting this, leading to net cash of CN¥713.4m.

How Strong Is Sinotrans' Balance Sheet?

According to the last reported balance sheet, Sinotrans had liabilities of CN¥28.7b due within 12 months, and liabilities of CN¥14.9b due beyond 12 months. On the other hand, it had cash of CN¥13.7b and CN¥19.6b worth of receivables due within a year. So its liabilities total CN¥10.3b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sinotrans has a market capitalization of CN¥25.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Sinotrans boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Sinotrans has increased its EBIT by 5.4% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sinotrans can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sinotrans has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Sinotrans actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Sinotrans does have more liabilities than liquid assets, it also has net cash of CN¥713.4m. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in CN¥2.9b. So we don't think Sinotrans's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sinotrans you should know about.

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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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.