Sterling Group Holdings (HKG:1825) Has Debt But No Earnings; Should You Worry?

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.' 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 can see that Sterling Group Holdings Limited (HKG:1825) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sterling Group Holdings

What Is Sterling Group Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sterling Group Holdings had HK$249.7m of debt in September 2021, down from HK$280.7m, one year before. However, it does have HK$53.8m in cash offsetting this, leading to net debt of about HK$196.0m.

A Look At Sterling Group Holdings' Liabilities

We can see from the most recent balance sheet that Sterling Group Holdings had liabilities of HK$346.5m falling due within a year, and liabilities of HK$29.7m due beyond that. Offsetting these obligations, it had cash of HK$53.8m as well as receivables valued at HK$241.0m due within 12 months. So it has liabilities totalling HK$81.4m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the HK$42.8m 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 definitely think shareholders need to watch this one closely. At the end of the day, Sterling Group Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sterling Group Holdings 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.

Over 12 months, Sterling Group Holdings made a loss at the EBIT level, and saw its revenue drop to HK$423m, which is a fall of 10.0%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Sterling Group Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable HK$35m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of HK$10m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sterling Group Holdings you should know about.

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.

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.

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