Is Sinostar PEC Holdings (SGX:C9Q) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Sinostar PEC Holdings Limited (SGX:C9Q) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Sinostar PEC Holdings

How Much Debt Does Sinostar PEC Holdings Carry?

The image below, which you can click on for greater detail, shows that Sinostar PEC Holdings had debt of CN¥1.08b at the end of March 2022, a reduction from CN¥1.19b over a year. However, because it has a cash reserve of CN¥556.4m, its net debt is less, at about CN¥523.6m.

A Look At Sinostar PEC Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Sinostar PEC Holdings had liabilities of CN¥443.4m due within 12 months and liabilities of CN¥823.9m due beyond that. On the other hand, it had cash of CN¥556.4m and CN¥89.5m worth of receivables due within a year. So its liabilities total CN¥621.3m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥721.8m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.90 times EBITDA, Sinostar PEC Holdings is arguably pretty conservatively geared. And it boasts interest cover of 9.2 times, which is more than adequate. Also positive, Sinostar PEC Holdings grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sinostar PEC 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Sinostar PEC Holdings's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Sinostar PEC Holdings's EBIT growth rate should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think Sinostar PEC Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Sinostar PEC Holdings .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.