Howard Marks put it well when he said, rather than worrying about the volatility of the stock price,’ the possibility of permanent loss is the risk I fear. . . and every practical investor I know worries. “It’s only natural to consider a company’s balance sheet when examining how risky it is, as debt often arises when a company collapses. We note that Sinotruk (Hong Kong) Limited (HKG: 3808) has debt on its balance sheet. But is this debt a concern of shareholders?
In general, debt only becomes a real problem if a company cannot simply pay it off, either by raising capital or with its own cash flow. Ultimately, if the company fails to meet its legal debt repayment obligations, shareholders cannot get away with anything. However, a more common (but still costly) occurrence is when a company needs to issue stocks at cheap prices and permanently dilute shareholders in order to prop up its balance sheet. Of course, many companies use debt to fund growth without facing any negative consequences. The first step in looking at a company’s debt is to look at its cash and debt together.
You can click the graph below to view the historical numbers. However, it shows that Sinotruk (Hong Kong) had CN ¥ 1. 42b debt in June 2020 of 1 CN ¥. 64b, a year earlier. But it also has CN ¥ 32. 0b in cash to offset this which means it has CN ¥ 30. 6b net cash.
The latest balance sheet data shows Sinotruk, Hong Kong, had debt of CNY 56. 9b due within one year and liabilities of CN ¥ 1. 47b due afterwards. The company had cash on hand against these commitments of CNY 32. 0b and claims worth CNY 21. 3b due within 12 months. So it has liabilities of 5 CN ¥. 09b more than cash and short-term receivables combined.
Of course, Sinotruk (Hong Kong) has a market capitalization of CNY 42. 8b, so these liabilities are likely to be manageable. However, there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. Sinotruk, Hong Kong, has notable liabilities, but it also has more cash than debt. So we are pretty confident that it can safely manage its debt.
But the other side of the story is Sinotruk (Hong Kong) saw EBIT drop by 7. 2% last year. If profits continue to decline at this rate, the company may find it increasingly difficult to manage its debt burden. There is no doubt that we learn the most about debt from the balance sheet. Ultimately, however, the future profitability of the business will determine whether Sinotruk (Hong Kong) can strengthen its balance sheet over time. So if you want to see what the professionals are thinking, this free analyst earnings forecast report might be of interest.
Our final consideration is also important because a company cannot pay debts with paper profits. it takes hard cash. While Sinotruk (Hong Kong) has a net present value on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and taxes (EBIT) to free cash flow to understand how quickly it’s building (or eroded)) the cash balance. For the past three years, Sinotruk (Hong Kong) has had free cash flow equal to 59% of its EBIT, which is pretty normal given the free cash flow excluding interest and taxes. That cold cash means it can reduce its debt if it wants to.
Although Sinotruk, Hong Kong’s balance sheet is not particularly strong due to its total debt, it is clearly positive to see that it has a net present value of CN ¥ 30. 6b. So we have no problem with Sinotruk (Hong Kong) using debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all of the investment risk is on the balance sheet – far from it. For example, consider risks. Every company has them, and we’ve spotted 1 Sinotruk (Hong Kong) Warning Sign that you should know about.
If you are interested in investing in companies that can make profits without the burden of debt, check out this free list of growing companies that have net money on their balance sheets.
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World News – AU – Here’s why Sinotruk, Hong Kong (HKG: 3808) can responsibly manage its debt
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