Sunray Engineering Group (HKG:8616) Has A Pretty Healthy Balance Sheet

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. 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.

Why Does Debt Bring Risk?

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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out 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 at September 2022 Sunray Engineering Group had debt of HK$24.3m, up from HK$21.3m in one year. However, its balance sheet shows it holds HK$41.3m in cash, so it actually has HK$17.0m net cash.

How Strong Is Sunray Engineering Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunray Engineering Group had liabilities of HK$79.4m due within 12 months and liabilities of HK$3.29m due beyond that. Offsetting this, it had HK$41.3m in cash and HK$145.1m in receivables that were due within 12 months. So it actually has HK$103.8m 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. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Sunray Engineering Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Sunray Engineering Group if management cannot prevent a repeat of the 54% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 that may be a result of expenditure for growth, it does make the debt far 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$17.0m and plenty of liquid assets. So we don't have any problem with Sunray Engineering Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sunray Engineering Group is showing 3 warning signs in our investment analysis , and 2 of those are concerning...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.