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. As with many other companies Sino-i Technology Limited (HKG:250) makes use of debt. But should shareholders be worried about its use of debt?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sino-i Technology's Net Debt?
As you can see below, Sino-i Technology had HK$5.54m of debt at December 2018, down from HK$168.9m a year prior. But on the other hand it also has HK$301.3m in cash, leading to a HK$295.8m net cash position.
How Strong Is Sino-i Technology's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sino-i Technology had liabilities of HK$529.4m due within 12 months and liabilities of HK$31.7m due beyond that. Offsetting these obligations, it had cash of HK$301.3m as well as receivables valued at HK$1.17b due within 12 months. So it actually has HK$907.1m more liquid assets than total liabilities.
This surplus strongly suggests that Sino-i Technology has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Sino-i Technology has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sino-i Technology'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, Sino-i Technology reported revenue of HK$1.0b, which is a gain of 22%. With any luck the company will be able to grow its way to profitability.
So How Risky Is Sino-i Technology?
While Sino-i Technology lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of HK$377m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. We also take heart from the solid 22% revenue growth in 12 months; undoubtedly a good sign. So this may well be an interesting business to watch grow. For riskier companies like Sino-i Technology I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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