These 4 Measures Indicate That Sino Horizon Holdings (TPE:2923) Is Using Debt Extensively

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.' 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 note that Sino Horizon Holdings Limited (TPE:2923) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sino Horizon Holdings

What Is Sino Horizon Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Sino Horizon Holdings had debt of NT$49.2b, up from NT$47.3b in one year. However, it also had NT$8.89b in cash, and so its net debt is NT$40.3b.

How Healthy Is Sino Horizon Holdings' Balance Sheet?

According to the last reported balance sheet, Sino Horizon Holdings had liabilities of NT$7.99b due within 12 months, and liabilities of NT$54.4b due beyond 12 months. Offsetting this, it had NT$8.89b in cash and NT$866.9m in receivables that were due within 12 months. So it has liabilities totalling NT$52.6b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of NT$58.5b, so it does suggest shareholders should keep an eye on Sino Horizon Holdings' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Sino Horizon Holdings has a sky high EBITDA ratio of 8.3, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Sino Horizon Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 128% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sino Horizon 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sino Horizon Holdings reported free cash flow worth 7.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While Sino Horizon Holdings's net debt to EBITDA has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. We think that Sino Horizon Holdings's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Sino Horizon Holdings has 4 warning signs (and 2 which make us uncomfortable) we think you should know about.

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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