Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk. It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Sky Light Holdings Limited (HKG:3882) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Sky Light Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Sky Light Holdings had HK$24.3m of debt in June 2019, down from HK$62.0m, one year before. But on the other hand it also has HK$138.2m in cash, leading to a HK$113.9m net cash position.
A Look At Sky Light Holdings's Liabilities
We can see from the most recent balance sheet that Sky Light Holdings had liabilities of HK$184.2m falling due within a year, and liabilities of HK$44.0m due beyond that. Offsetting this, it had HK$138.2m in cash and HK$55.1m in receivables that were due within 12 months. So its liabilities total HK$34.9m more than the combination of its cash and short-term receivables.
Given Sky Light Holdings has a market capitalization of HK$290.6m, 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. Despite its noteworthy liabilities, Sky Light Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Sky Light Holdings turned things around in the last 12 months, delivering and EBIT of HK$121m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sky Light Holdings's ability to maintain a healthy balance sheet going forward. 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. While Sky Light Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, Sky Light Holdings reported free cash flow worth 7.7% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While Sky Light Holdings does have more liabilities than liquid assets, it also has net cash of HK$113.9m. So we are not troubled with Sky Light Holdings's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Sky Light Holdings insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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