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.' 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. As with many other companies SRP Groupe S.A. (EPA:SRP) makes use of debt. But is this debt a concern to shareholders?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is SRP Groupe's Debt?
As you can see below, at the end of June 2020, SRP Groupe had €100.0m of debt, up from €42.2m a year ago. Click the image for more detail. However, it does have €118.3m in cash offsetting this, leading to net cash of €18.3m.
How Strong Is SRP Groupe's Balance Sheet?
According to the last reported balance sheet, SRP Groupe had liabilities of €200.9m due within 12 months, and liabilities of €118.5m due beyond 12 months. On the other hand, it had cash of €118.3m and €41.0m worth of receivables due within a year. So it has liabilities totalling €160.0m more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the €100.5m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, SRP Groupe would likely require a major re-capitalisation if it had to pay its creditors today. Given that SRP Groupe has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SRP Groupe can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year SRP Groupe had a loss before interest and tax, and actually shrunk its revenue by 6.4%, to €616m. That's not what we would hope to see.
So How Risky Is SRP Groupe?
While SRP Groupe lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow €23m. 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. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. 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. Case in point: We've spotted 2 warning signs for SRP Groupe you should be aware of, and 1 of them is a bit concerning.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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