Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu doesn’t care when he says, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital ”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We can see that Suoxinda Holdings Limited (HKG: 3680) uses debt in its business. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until it struggles to pay it off, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance growth without any negative consequences. The first thing to do when considering how much debt a business is using is to look at its cash flow and debt together.
Check out our latest analysis for Suoxinda Holdings
What is the debt of Suoxinda Holdings?
As you can see below, at the end of December 2020, Suoxinda Holdings had CNY 87.3million in debt, up from CNN 66.9million a year ago. Click on the image for more details. However, he also had 80.9 million yen in cash, so his net debt is 6.43 million yen.
How strong is Suoxinda Holdings’ balance sheet?
According to the latest published balance sheet, Suoxinda Holdings had commitments of 228.7 million yen due within 12 months and commitments of 35.8 million yen over 12 months. In return for these obligations, he had cash of 80.9 million yen as well as receivables valued at 218.9 million yen, due within 12 months. He can therefore boast of having CNY 35.3 million more liquid assets than total Liabilities.
This fact indicates that Suoxinda Holdings’ balance sheet looks quite strong, as its total liabilities roughly equal its liquid assets. So the 2.24 billion yen company is highly unlikely to run out of cash, but it’s still worth keeping an eye on the balance sheet. But either way, Suoxinda Holdings has virtually no net debt, so it’s fair to say that she doesn’t have heavy debt!
In order to size a company’s debt against its profit, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest expense. (its interest coverage). In this way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Suoxinda Holdings has a very low debt to EBITDA ratio of 0.52 so it is strange to see low interest coverage as last year’s EBIT was only 2.5 times the interest expense. So one way or another, it’s clear that debt levels are not trivial. Importantly, Suoxinda Holdings’ EBIT has fallen 71% over the past twelve months. If this decline continues, it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. There is no doubt that we learn the most about debt from the balance sheet. But it is the profits of Suoxinda Holdings that will influence the performance of the balance sheet in the future. So when you consider debt, it is definitely worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business can only pay off its debts with cash, not book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Suoxinda Holdings has experienced substantial negative free cash flow, in total. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
At first glance, Suoxinda Holdings’ conversion of EBIT to free cash flow left us hesitant about the stock, and its EBIT growth rate was no more attractive than the only empty restaurant overnight. busiest of the year. But at least it’s decent enough to manage your debt, based on your EBITDA; it’s encouraging. Once we consider all of the above factors together, it seems like Suoxinda Holdings’ debt makes it a bit risky. This isn’t necessarily a bad thing, but we would generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Suoxinda Holdings you need to be aware of this, and 2 of them cannot be ignored.
If you want to invest in companies that can generate profits without the burden of debt, check out this free list of growing companies that have net cash on the balance sheet.
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