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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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 Sinofert Holdings Limited (HKG:297) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
View our latest analysis for Sinofert Holdings
What Is Sinofert Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Sinofert Holdings had CN¥4.14b of debt, an increase on CN¥3.56b, over one year. However, it does have CN¥2.58b in cash offsetting this, leading to net debt of about CN¥1.56b.
A Look At Sinofert Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Sinofert Holdings had liabilities of CN¥9.85b due within 12 months and liabilities of CN¥373.2m due beyond that. Offsetting these obligations, it had cash of CN¥2.58b as well as receivables valued at CN¥3.86b due within 12 months. So its liabilities total CN¥3.79b more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of CN¥5.34b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
We'd say that Sinofert Holdings's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. We also note that Sinofert Holdings improved its EBIT from a last year's loss to a positive CN¥425m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sinofert Holdings 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.