Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Above all, Sincere Watch (Hong Kong) Limited (HKG:444) is in debt. But does this debt worry shareholders?
When is debt dangerous?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. That said, the most common situation is when a company manages its debt reasonably well – and to its own benefit. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Sincere Watch (Hong Kong)
What is the debt of Sincere Watch (Hong Kong)?
As you can see below, at the end of March 2022, Sincere Watch (Hong Kong) had a debt of HK$295.1 million, compared to HK$266.0 million a year ago. Click on the image for more details. However, since it has a cash reserve of HK$91.2 million, its net debt is lower at around HK$203.9 million.
How healthy is the balance sheet of Sincere Watch (Hong Kong)?
According to the last published balance sheet, Sincere Watch (Hong Kong) had liabilities of HK$170.2 million maturing within 12 months and liabilities of HK$301.1 million maturing beyond 12 months. As compensation for these obligations, it had cash of HK$91.2 million and receivables valued at HK$40.0 million due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of HK$340.2 million.
When you consider that shortfall exceeds the company’s HK$241.8 million market capitalization, you might well be inclined to take a close look at the balance sheet. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Sincere Watch (Hong Kong) that will influence the performance of the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
Last year, Sincere Watch (Hong Kong) was not profitable in terms of EBIT, but managed to increase its turnover by 9.1%, to HK$149 million. We generally like to see faster growth from unprofitable businesses, but each in its own way.
Caveat Emptor
Over the last twelve months, Sincere Watch (Hong Kong) recorded a loss of earnings before interest and taxes (EBIT). Indeed, it lost a very considerable HK$50 million in EBIT. Considering that alongside the liabilities mentioned above, we are nervous about the business. It would have to quickly improve its functioning so that we are interested in it. It’s fair to say that the loss of HK$157 million didn’t cheer us up either; we would like to see a profit. And until then, we think it’s a risky stock. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Sincere Watch (Hong Kong) (of which 1 does not suit us too much!) that you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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