Is Sports Entertainment Group (ASX:SEG) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sports Entertainment Group Limited (ASX:SEG) does carry debt. But is this debt a concern to shareholders?

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When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Sports Entertainment Group's Debt?

As you can see below, Sports Entertainment Group had AU$12.0m of debt at December 2024, down from AU$28.0m a year prior. However, because it has a cash reserve of AU$11.9m, its net debt is less, at about AU$120.0k.

How Healthy Is Sports Entertainment Group's Balance Sheet?

We can see from the most recent balance sheet that Sports Entertainment Group had liabilities of AU$26.6m falling due within a year, and liabilities of AU$45.3m due beyond that. Offsetting this, it had AU$11.9m in cash and AU$19.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$40.8m.

This deficit isn't so bad because Sports Entertainment Group is worth AU$70.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Carrying virtually no net debt, Sports Entertainment Group has a very light debt load indeed.

See our latest analysis for Sports Entertainment Group

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). 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).

Sports Entertainment Group has a net debt to EBITDA ratio of 0.015, suggesting a very conservative balance sheet. But strangely, EBIT was only 1.5 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. Pleasingly, Sports Entertainment Group is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 236% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sports Entertainment Group's earnings that will influence how the balance sheet holds up in the future. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Sports Entertainment Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, Sports Entertainment Group's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its interest cover has the opposite effect. When we consider the range of factors above, it looks like Sports Entertainment Group 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Sports Entertainment Group (1 can't be ignored!) that you should be aware of before investing here.

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.