Does Sutton Harbour Group (LON:SUH) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Sutton Harbour Group plc (LON:SUH) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sutton Harbour Group

What Is Sutton Harbour Group's Net Debt?

As you can see below, at the end of September 2020, Sutton Harbour Group had UK£24.3m of debt, up from UK£23.0m a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

A Look At Sutton Harbour Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Sutton Harbour Group had liabilities of UK£2.16m due within 12 months and liabilities of UK£26.6m due beyond that. On the other hand, it had cash of UK£177.0k and UK£2.36m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£26.2m.

Given this deficit is actually higher than the company's market capitalization of UK£19.1m, we think shareholders really should watch Sutton Harbour Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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.

Sutton Harbour Group shareholders face the double whammy of a high net debt to EBITDA ratio (21.7), and fairly weak interest coverage, since EBIT is just 0.96 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Sutton Harbour Group saw its EBIT tank 34% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sutton Harbour 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Sutton Harbour Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Sutton Harbour Group's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its net debt to EBITDA also fails to instill confidence. We should also note that Infrastructure industry companies like Sutton Harbour Group commonly do use debt without problems. Considering all the factors previously mentioned, we think that Sutton Harbour Group really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. Case in point: We've spotted 3 warning signs for Sutton Harbour Group you should be aware of, and 2 of them shouldn't be ignored.

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. 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.
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