Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually linked to bankruptcies – is a very important factor when you assess the risk of a business. We can see that Shun Tak Holdings Limited (HKG: 242) uses debt in his business. But does this debt worry shareholders?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. That said, the most common situation is where a business manages its debt reasonably well – and to its advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest analysis for Shun Tak Holdings

What is the net debt of Shun Tak Holdings?

The image below, which you can click for more details, shows that Shun Tak Holdings had HK $ 18.0 billion in debt at the end of December 2020, a reduction of HK $ 19.4 billion. of Hong Kong dollars over one year. On the other hand, he has 5.48 billion Hong Kong dollars in cash, resulting in net debt of around 12.5 billion Hong Kong dollars.

A look at the responsibilities of Shun Tak Holdings

We can see from the most recent balance sheet that Shun Tak Holdings had HK $ 6.10 billion in liabilities due within one year, and HK $ 16.9 billion in liabilities due beyond. In return for these obligations, he had cash of HK $ 5.48 billion as well as claims valued at HK $ 974.1 million with a 12-month maturity. Thus, its liabilities total HK $ 16.6 billion more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the Hong Kong $ 7.37 billion company itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and clothes. ‘a trumpet. We would therefore monitor its record closely, without a doubt. Ultimately, Shun Tak Holdings would likely need a major recapitalization if its creditors demanded repayment.

We use two main ratios to tell us about leverage versus earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its earnings before interest and taxes (EBIT) covers its interest expense (or interest coverage, in short). The advantage of this approach is that we take into account both the absolute quantum of the debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).

Shun Tak Holdings has a rather high debt to EBITDA ratio of 8.5, which suggests significant leverage. But the good news is that it has a fairly reassuring 3.8 times interest coverage, which suggests that it can meet its obligations responsibly. Worse yet, Shun Tak Holdings has seen its EBIT reach 80% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Shun Tak Holdings can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a company cannot pay its debt with profits on paper; he needs cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Shun Tak Holdings has recorded free cash flow of 27% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.

Our point of view

To be blunt, both Shun Tak Holdings’ EBIT growth rate and track record of taming its total liabilities make us quite uncomfortable with its leverage levels. And even his coverage of interest doesn’t inspire much confidence. Considering all of the aforementioned factors, it appears that Shun Tak Holdings has too much debt. If some investors like this kind of risky game, this is certainly not our cup of tea. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Shun Tak Holdings you need to be aware of that, and one of them is a bit nasty.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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