Here's Why Sunray Engineering Group (HKG:8616) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Sunray Engineering Group Limited (HKG:8616) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sunray Engineering Group

What Is Sunray Engineering Group's Net Debt?

The image below, which you can click on for greater detail, shows that Sunray Engineering Group had debt of HK$23.6m at the end of March 2023, a reduction from HK$25.2m over a year. But on the other hand it also has HK$29.4m in cash, leading to a HK$5.85m net cash position.

A Look At Sunray Engineering Group's Liabilities

The latest balance sheet data shows that Sunray Engineering Group had liabilities of HK$66.6m due within a year, and liabilities of HK$3.34m falling due after that. On the other hand, it had cash of HK$29.4m and HK$157.2m worth of receivables due within a year. So it actually has HK$116.7m more liquid assets than total liabilities.

This luscious liquidity implies that Sunray Engineering Group's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Sunray Engineering Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Sunray Engineering Group's saving grace is its low debt levels, because its EBIT has tanked 44% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sunray Engineering Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sunray Engineering 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. During the last three years, Sunray Engineering Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, the bottom line is that Sunray Engineering Group has net cash of HK$5.85m and plenty of liquid assets. So we don't have any problem with Sunray Engineering Group's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sunray Engineering Group is showing 4 warning signs in our investment analysis , and 3 of those can't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.