Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Sprocomm Intelligence Limited (HKG:1401) makes use of debt. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Sprocomm Intelligence
What Is Sprocomm Intelligence's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2023 Sprocomm Intelligence had debt of CN¥116.4m, up from CN¥81.1m in one year. On the flip side, it has CN¥61.6m in cash leading to net debt of about CN¥54.8m.
A Look At Sprocomm Intelligence's Liabilities
We can see from the most recent balance sheet that Sprocomm Intelligence had liabilities of CN¥1.04b falling due within a year, and liabilities of CN¥26.9m due beyond that. Offsetting this, it had CN¥61.6m in cash and CN¥618.5m in receivables that were due within 12 months. So it has liabilities totalling CN¥384.4m more than its cash and near-term receivables, combined.
Given Sprocomm Intelligence has a market capitalization of CN¥3.17b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sprocomm Intelligence's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Sprocomm Intelligence made a loss at the EBIT level, and saw its revenue drop to CN¥1.3b, which is a fall of 33%. To be frank that doesn't bode well.
Caveat Emptor
Not only did Sprocomm Intelligence's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥35m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥370m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sprocomm Intelligence is showing 4 warning signs in our investment analysis , and 3 of those are potentially serious...
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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