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Is Sitoy Group Holdings (HKG:1023) Using Too Much Debt?

Simply Wall St

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Sitoy Group Holdings Limited (HKG:1023) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sitoy Group Holdings

What Is Sitoy Group Holdings's Net Debt?

As you can see below, at the end of June 2019, Sitoy Group Holdings had HK$166.3m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has HK$433.5m in cash, leading to a HK$267.2m net cash position.

SEHK:1023 Historical Debt, October 21st 2019

How Healthy Is Sitoy Group Holdings's Balance Sheet?

The latest balance sheet data shows that Sitoy Group Holdings had liabilities of HK$566.9m due within a year, and liabilities of HK$5.09m falling due after that. Offsetting these obligations, it had cash of HK$433.5m as well as receivables valued at HK$485.7m due within 12 months. So it can boast HK$347.2m more liquid assets than total liabilities.

It's good to see that Sitoy Group Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sitoy Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Sitoy Group Holdings's load is not too heavy, because its EBIT was down 47% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sitoy Group Holdings'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Sitoy Group Holdings 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 most recent three years, Sitoy Group Holdings recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sitoy Group Holdings has net cash of HK$267.2m, as well as more liquid assets than liabilities. So we don't have any problem with Sitoy Group Holdings's use of debt. Given Sitoy Group Holdings has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.