We Think Sam Woo Construction Group (HKG:3822) Is Taking Some Risk With Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Sam Woo Construction Group Limited (HKG:3822) does use debt in its business. But the more important question is: how much risk is that debt creating?

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When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

What Is Sam Woo Construction Group's Debt?

The chart below, which you can click on for greater detail, shows that Sam Woo Construction Group had HK$247.1m in debt in March 2025; about the same as the year before. On the flip side, it has HK$124.8m in cash leading to net debt of about HK$122.3m.

How Healthy Is Sam Woo Construction Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sam Woo Construction Group had liabilities of HK$379.6m due within 12 months and liabilities of HK$61.8m due beyond that. On the other hand, it had cash of HK$124.8m and HK$205.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$111.0m.

This deficit casts a shadow over the HK$65.5m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Sam Woo Construction Group would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for Sam Woo Construction Group

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Sam Woo Construction Group has a quite reasonable net debt to EBITDA multiple of 2.0, its interest cover seems weak, at 2.1. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) In any case, it's safe to say the company has meaningful debt. Notably, Sam Woo Construction Group made a loss at the EBIT level, last year, but improved that to positive EBIT of HK$29m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sam Woo Construction Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Sam Woo Construction Group generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

To be frank both Sam Woo Construction Group's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Sam Woo Construction Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sam Woo Construction Group is showing 2 warning signs in our investment analysis , you should know about...

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.