Is Sunray Engineering Group (HKG:8616) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sunray Engineering Group Limited (HKG:8616) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for Sunray Engineering Group

What Is Sunray Engineering Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Sunray Engineering Group had HK$25.2m of debt, an increase on none, over one year. However, its balance sheet shows it holds HK$47.0m in cash, so it actually has HK$21.8m net cash.

How Healthy Is Sunray Engineering Group's Balance Sheet?

According to the last reported balance sheet, Sunray Engineering Group had liabilities of HK$73.7m due within 12 months, and liabilities of HK$2.42m due beyond 12 months. Offsetting this, it had HK$47.0m in cash and HK$136.6m in receivables that were due within 12 months. So it actually has HK$107.4m more liquid assets than total liabilities.

This excess liquidity is a great indication that Sunray Engineering Group's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. 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.

But the other side of the story is that Sunray Engineering Group saw its EBIT decline by 6.2% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sunray Engineering Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sunray Engineering Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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$21.8m and plenty of liquid assets. So we don't have any problem with Sunray Engineering Group's use of debt. 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. For example Sunray Engineering Group has 4 warning signs (and 2 which are significant) we think you should know about.

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.