Is Sino Gas Holdings Group (HKG:1759) Using Too Much Debt?

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 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. Importantly, Sino Gas Holdings Group Limited (HKG:1759) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sino Gas Holdings Group

What Is Sino Gas Holdings Group's Debt?

As you can see below, at the end of December 2021, Sino Gas Holdings Group had CN¥476.5m of debt, up from CN¥196.6m a year ago. Click the image for more detail. However, it does have CN¥77.5m in cash offsetting this, leading to net debt of about CN¥399.1m.

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¥504.7m due within 12 months, and liabilities of CN¥30.4m due beyond 12 months. On the other hand, it had cash of CN¥77.5m and CN¥122.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥335.4m.

The deficiency here weighs heavily on the CN¥149.4m 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'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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sino Gas Holdings 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.

Over 12 months, Sino Gas Holdings Group reported revenue of CN¥1.9b, which is a gain of 49%, 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¥2.0m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥18m and the profit of CN¥9.7m. So there is definitely a chance that it can improve things in the next few years. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Sino Gas Holdings Group has 5 warning signs (and 2 which can't be ignored) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.