Here’s Why SUNeVision Holdings (HKG:1686) Has Significant Leverage

Warren Buffett said: “Volatility is far from synonymous with risk. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Mostly, SUNeVision Holdings Ltd. (HKG:1686) is in debt. But should shareholders worry about its use of debt?

Why is debt risky?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. In the worst case, 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 at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Check out our latest analysis for SUNeVision Holdings

How much debt does SUNeVision Holdings have?

The image below, which you can click on for more details, shows that as of December 2021, SUNeVision Holdings had HK$11.4 billion in debt, up from HK$10.5 billion in one year. On the other hand, it has HK$332.7 million in cash, resulting in a net debt of around HK$11.1 billion.

SEHK: 1686 Historical Debt to Equity February 26, 2022

A look at the liabilities of SUNeVision Holdings

According to the latest published balance sheet, SUNeVision Holdings had liabilities of HK$3.11 billion due within 12 months and liabilities of HK$9.73 billion due beyond 12 months. On the other hand, it had cash of HK$332.7 million and HK$446.8 million of receivables due within one year. Thus, its liabilities total HK$12.1 billion more than the combination of its cash and short-term receivables.

This shortfall is not that bad as SUNeVision Holdings is worth HK$29.3 billion and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

As it happens, SUNeVision Holdings has a rather concerning net debt to EBITDA ratio of 10.0 but very high interest coverage of 145. This means that unless the company has access to very cheap debt , these interest charges are likely to increase in the future. We have seen SUNeVision Holdings increase its EBIT by 6.9% over the last twelve months. It’s far from amazing, but it’s a good thing when it comes to paying down debt. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether SUNeVision Holdings can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, SUNeVision Holdings has experienced substantial negative free cash flow, in total. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

SUNeVision Holdings’ conversion of EBIT to free cash flow and net debt to EBITDA is definitely weighing on it, in our view. But his coverage of interest tells a very different story and suggests a certain resilience. Considering the above factors, we believe that SUNeVision Holdings’ debt poses certain risks to the business. While this debt may increase returns, we believe the company now has sufficient leverage. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. To do this, you need to find out about the 3 warning signs we spotted with SUNeVision Holdings (including 2 that are a little worrying).

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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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John A. Bogar