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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sinoma International Engineering Co.,Ltd (SHSE:600970) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Sinoma International EngineeringLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Sinoma International EngineeringLtd had CN¥7.38b of debt, an increase on CN¥7.09b, over one year. However, its balance sheet shows it holds CN¥7.52b in cash, so it actually has CN¥137.9m net cash.
How Strong Is Sinoma International EngineeringLtd's Balance Sheet?
We can see from the most recent balance sheet that Sinoma International EngineeringLtd had liabilities of CN¥29.9b falling due within a year, and liabilities of CN¥3.28b due beyond that. Offsetting this, it had CN¥7.52b in cash and CN¥20.9b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.76b.
Since publicly traded Sinoma International EngineeringLtd shares are worth a total of CN¥29.0b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Sinoma International EngineeringLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Sinoma International EngineeringLtd grew its EBIT by 10% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sinoma International EngineeringLtd can strengthen its balance sheet over time. 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. Sinoma International EngineeringLtd 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. In the last three years, Sinoma International EngineeringLtd's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing Up
While Sinoma International EngineeringLtd does have more liabilities than liquid assets, it also has net cash of CN¥137.9m. And it also grew its EBIT by 10% over the last year. So we are not troubled with Sinoma International EngineeringLtd'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sinoma International EngineeringLtd you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.