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Is Sundart Holdings (HKG:1568) A Risky Investment?

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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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sundart Holdings Limited (HKG:1568) 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?

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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

See our latest analysis for Sundart Holdings

What Is Sundart Holdings’s Net Debt?

As you can see below, Sundart Holdings had HK$164.7m of debt at December 2020, down from HK$373.3m a year prior. However, it does have HK$1.57b in cash offsetting this, leading to net cash of HK$1.41b.

SEHK:1568 Debt to Equity History April 7th 2021

A Look At Sundart Holdings’ Liabilities

Zooming in on the latest balance sheet data, we can see that Sundart Holdings had liabilities of HK$3.28b due within 12 months and liabilities of HK$9.25m due beyond that. Offsetting this, it had HK$1.57b in cash and HK$3.58b in receivables that were due within 12 months. So it can boast HK$1.86b more liquid assets than total liabilities.

This luscious liquidity implies that Sundart Holdings’ balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Sundart Holdings boasts net cash, so it’s fair to say it does not have a heavy debt load!

While Sundart Holdings doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sundart Holdings’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sundart Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Sundart Holdings recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sundart Holdings has net cash of HK$1.41b, as well as more liquid assets than liabilities. So we don’t think Sundart Holdings’s use of debt is risky. 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. Be aware that Sundart Holdings is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning…

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. 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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