Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Sunny Side Up Culture Holdings Limited (HKG:8082) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Sunny Side Up Culture Holdings
What Is Sunny Side Up Culture Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Sunny Side Up Culture Holdings had HK$35.0m of debt in June 2024, down from HK$95.0m, one year before. However, its balance sheet shows it holds HK$90.4m in cash, so it actually has HK$55.4m net cash.
How Healthy Is Sunny Side Up Culture Holdings' Balance Sheet?
We can see from the most recent balance sheet that Sunny Side Up Culture Holdings had liabilities of HK$104.2m falling due within a year, and liabilities of HK$39.4m due beyond that. Offsetting these obligations, it had cash of HK$90.4m as well as receivables valued at HK$43.8m due within 12 months. So its liabilities total HK$9.51m more than the combination of its cash and short-term receivables.
Of course, Sunny Side Up Culture Holdings has a market capitalization of HK$211.3m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sunny Side Up Culture Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Notably, Sunny Side Up Culture Holdings made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$22m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sunny Side Up Culture Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sunny Side Up Culture Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last year, Sunny Side Up Culture Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
While it is always sensible to look at a company's total liabilities, it is very reassuring that Sunny Side Up Culture Holdings has HK$55.4m in net cash. So we are not troubled with Sunny Side Up Culture Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Sunny Side Up Culture Holdings you should be aware of, and 2 of them are concerning.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.