Is Sempra (NYSE:SRE) A Risky Investment?

By
Simply Wall St
Published
November 07, 2021
NYSE:SRE
Source: Shutterstock

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. Importantly, Sempra (NYSE:SRE) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sempra

How Much Debt Does Sempra Carry?

The image below, which you can click on for greater detail, shows that at September 2021 Sempra had debt of US$26.4b, up from US$24.6b in one year. However, it also had US$873.0m in cash, and so its net debt is US$25.5b.

debt-equity-history-analysis
NYSE:SRE Debt to Equity History November 8th 2021

A Look At Sempra's Liabilities

According to the last reported balance sheet, Sempra had liabilities of US$12.9b due within 12 months, and liabilities of US$32.9b due beyond 12 months. Offsetting this, it had US$873.0m in cash and US$2.01b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$43.0b.

When you consider that this deficiency exceeds the company's huge US$40.7b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sempra has a rather high debt to EBITDA ratio of 5.9 which suggests a meaningful debt load. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. Even more troubling is the fact that Sempra actually let its EBIT decrease by 5.6% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sempra's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Sempra burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Sempra's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. We should also note that Integrated Utilities industry companies like Sempra commonly do use debt without problems. We're quite clear that we consider Sempra to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For instance, we've identified 5 warning signs for Sempra (1 makes us a bit uncomfortable) you should be aware of.

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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