Is Stealth Group Holdings (ASX:SGI) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that Stealth Group Holdings Ltd (ASX:SGI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Stealth Group Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2024 Stealth Group Holdings had debt of AU$21.4m, up from AU$14.5m in one year. However, it does have AU$10.4m in cash offsetting this, leading to net debt of about AU$11.0m.

How Healthy Is Stealth Group Holdings' Balance Sheet?

According to the last reported balance sheet, Stealth Group Holdings had liabilities of AU$52.1m due within 12 months, and liabilities of AU$11.9m due beyond 12 months. On the other hand, it had cash of AU$10.4m and AU$17.6m worth of receivables due within a year. So it has liabilities totalling AU$35.9m more than its cash and near-term receivables, combined.

Stealth Group Holdings has a market capitalization of AU$87.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

View our latest analysis for Stealth Group Holdings

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Stealth Group Holdings has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.8 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. It is well worth noting that Stealth Group Holdings's EBIT shot up like bamboo after rain, gaining 64% in the last twelve months. That'll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Stealth Group Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Stealth Group Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Stealth Group Holdings's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its interest cover. When we consider the range of factors above, it looks like Stealth Group Holdings is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Stealth Group Holdings you should be aware of, and 1 of them makes us a bit uncomfortable.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.