The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Sinotrans Limited (HKG:598) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Sinotrans
As you can see below, Sinotrans had CN¥9.72b of debt at September 2024, down from CN¥12.3b a year prior. But on the other hand it also has CN¥12.0b in cash, leading to a CN¥2.24b net cash position.
We can see from the most recent balance sheet that Sinotrans had liabilities of CN¥32.1b falling due within a year, and liabilities of CN¥8.46b due beyond that. Offsetting this, it had CN¥12.0b in cash and CN¥22.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.44b.
Since publicly traded Sinotrans shares are worth a total of CN¥33.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Sinotrans also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also good is that Sinotrans grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sinotrans can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sinotrans 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. During the last three years, Sinotrans generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While Sinotrans does have more liabilities than liquid assets, it also has net cash of CN¥2.24b. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in CN¥2.3b. So we don't think Sinotrans's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Sinotrans has 1 warning sign we think you should be aware of.
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.
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