Is SRE Group (HKG:1207) Using Debt Sensibly?

Warren Buffett famously said, '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 SRE Group Limited (HKG:1207) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SRE Group

What Is SRE Group's Net Debt?

As you can see below, SRE Group had CN¥4.58b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥379.7m in cash leading to net debt of about CN¥4.20b.

How Healthy Is SRE Group's Balance Sheet?

According to the last reported balance sheet, SRE Group had liabilities of CN¥5.22b due within 12 months, and liabilities of CN¥4.50b due beyond 12 months. Offsetting these obligations, it had cash of CN¥379.7m as well as receivables valued at CN¥2.97b due within 12 months. So its liabilities total CN¥6.37b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥818.2m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, SRE Group would probably need a major re-capitalization if its creditors were to demand repayment. 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 SRE 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.

In the last year SRE Group had a loss before interest and tax, and actually shrunk its revenue by 55%, to CN¥289m. That makes us nervous, to say the least.

Caveat Emptor

While SRE Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥183m at the EBIT level. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it burned through CN¥242m in the last year. So is this a high risk stock? We think so, and we'd avoid it. 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. To that end, you should be aware of the 1 warning sign we've spotted with SRE Group .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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