Is Sino Gas Holdings Group (HKG:1759) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Sino Gas Holdings Group Limited (HKG:1759) 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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that 1759 is potentially overvalued!

What Is Sino Gas Holdings Group's Debt?

As you can see below, Sino Gas Holdings Group had CN¥557.5m of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥103.4m in cash leading to net debt of about CN¥454.1m.

How Healthy Is Sino Gas Holdings Group's Balance Sheet?

According to the last reported balance sheet, Sino Gas Holdings Group had liabilities of CN¥591.3m due within 12 months, and liabilities of CN¥12.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥103.4m as well as receivables valued at CN¥170.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥330.0m.

This deficit casts a shadow over the CN¥128.3m 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, Sino Gas Holdings 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 Sino Gas Holdings Group will need earnings to service that debt. 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.

Over 12 months, Sino Gas Holdings Group reported revenue of CN¥2.3b, which is a gain of 60%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Even though Sino Gas Holdings Group managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at CN¥989k. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But on the bright side the company actually produced a statutory profit of CN¥9.2m and free cash flow of CN¥26m. So there is arguably potential that the company is going to turn things around. 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. To that end, you should learn about the 5 warning signs we've spotted with Sino Gas Holdings Group (including 2 which don't sit too well with us) .

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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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.