David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Sinotruk (Hong Kong) Limited (HKG:3808) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sinotruk (Hong Kong)

How Much Debt Does Sinotruk (Hong Kong) Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Sinotruk (Hong Kong) had CN¥4.88b of debt, an increase on CN¥2.90b, over one year. However, its balance sheet shows it holds CN¥31.3b in cash, so it actually has CN¥26.4b net cash.

A Look At Sinotruk (Hong Kong)'s Liabilities

According to the last reported balance sheet, Sinotruk (Hong Kong) had liabilities of CN¥57.5b due within 12 months, and liabilities of CN¥1.25b due beyond 12 months. On the other hand, it had cash of CN¥31.3b and CN¥16.8b worth of receivables due within a year. So it has liabilities totalling CN¥10.7b more than its cash and near-term receivables, combined.

Sinotruk (Hong Kong) has a market capitalization of CN¥18.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Sinotruk (Hong Kong) also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Sinotruk (Hong Kong)'s saving grace is its low debt levels, because its EBIT has tanked 85% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Sinotruk (Hong Kong)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinotruk (Hong Kong) 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 last three years, Sinotruk (Hong Kong) recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While Sinotruk (Hong Kong) does have more liabilities than liquid assets, it also has net cash of CN¥26.4b. And it impressed us with free cash flow of -CN¥5.8b, being 82% of its EBIT. So we are not troubled with Sinotruk (Hong Kong)'s debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Sinotruk (Hong Kong) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.