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 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 SRG Global Limited (ASX:SRG) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 SRG Global's Net Debt?
The image below, which you can click on for greater detail, shows that SRG Global had debt of AU$35.0m at the end of December 2020, a reduction from AU$45.0m over a year. However, it does have AU$40.4m in cash offsetting this, leading to net cash of AU$5.45m.
How Strong Is SRG Global's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that SRG Global had liabilities of AU$144.9m due within 12 months and liabilities of AU$46.1m due beyond that. Offsetting this, it had AU$40.4m in cash and AU$109.2m in receivables that were due within 12 months. So it has liabilities totalling AU$41.3m more than its cash and near-term receivables, combined.
Since publicly traded SRG Global shares are worth a total of AU$207.3m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, SRG Global boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if SRG Global can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, SRG Global reported revenue of AU$538m, which is a gain of 2.2%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.
So How Risky Is SRG Global?
While SRG Global lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$30m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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. For example - SRG Global has 1 warning sign we think you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you decide to trade SRG Global, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
Valuation is complex, but we're helping make it simple.
Find out whether SRG Global is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.