Star Entertainment Group (ASX:SGR) Takes On Some Risk With Its Use Of 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that The Star Entertainment Group Limited (ASX:SGR) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Star Entertainment Group

What Is Star Entertainment Group's Net Debt?

As you can see below, Star Entertainment Group had AU$265.2m of debt at December 2023, down from AU$1.29b a year prior. But it also has AU$436.3m in cash to offset that, meaning it has AU$171.1m net cash.

How Strong Is Star Entertainment Group's Balance Sheet?

The latest balance sheet data shows that Star Entertainment Group had liabilities of AU$707.1m due within a year, and liabilities of AU$312.1m falling due after that. Offsetting these obligations, it had cash of AU$436.3m as well as receivables valued at AU$44.0m due within 12 months. So its liabilities total AU$538.9m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Star Entertainment Group is worth AU$1.39b, and thus could probably raise enough capital to shore up 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. While it does have liabilities worth noting, Star Entertainment Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Importantly, Star Entertainment Group's EBIT fell a jaw-dropping 80% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Star Entertainment Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Star Entertainment Group 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. In the last three years, Star Entertainment Group's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Star Entertainment Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$171.1m. Despite its cash we think that Star Entertainment Group seems to struggle to grow its EBIT, so we are wary of the stock. 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. Case in point: We've spotted 1 warning sign for Star Entertainment Group 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.

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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.