Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Sinotruk (Hong Kong) Limited (HKG:3808) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sinotruk (Hong Kong)'s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2024 Sinotruk (Hong Kong) had CN¥5.70b of debt, an increase on CN¥5.05b, over one year. But on the other hand it also has CN¥34.4b in cash, leading to a CN¥28.7b net cash position.
How Healthy Is Sinotruk (Hong Kong)'s Balance Sheet?
The latest balance sheet data shows that Sinotruk (Hong Kong) had liabilities of CN¥79.1b due within a year, and liabilities of CN¥1.57b falling due after that. Offsetting these obligations, it had cash of CN¥34.4b as well as receivables valued at CN¥27.3b due within 12 months. So its liabilities total CN¥18.9b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Sinotruk (Hong Kong) has a market capitalization of CN¥57.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Sinotruk (Hong Kong) boasts net cash, so it's fair to say it does not have a heavy debt load!
Check out our latest analysis for Sinotruk (Hong Kong)
Another good sign is that Sinotruk (Hong Kong) has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sinotruk (Hong Kong)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sinotruk (Hong Kong) 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. Happily for any shareholders, Sinotruk (Hong Kong) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing Up
While Sinotruk (Hong Kong) does have more liabilities than liquid assets, it also has net cash of CN¥28.7b. And it impressed us with free cash flow of CN¥12b, being 189% of its EBIT. So we don't think Sinotruk (Hong Kong)'s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Sinotruk (Hong Kong) .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.