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. 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. As with many other companies Sino Gas Holdings Group Limited (HKG:1759) makes use of debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Sino Gas Holdings Group's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Sino Gas Holdings Group had CN¥261.7m of debt, an increase on CN¥194.0m, over one year. However, its balance sheet shows it holds CN¥279.8m in cash, so it actually has CN¥18.1m net cash.
A Look At Sino Gas Holdings Group's Liabilities
According to the balance sheet data, Sino Gas Holdings Group had liabilities of CN¥341.3m due within 12 months, but no longer term liabilities. Offsetting this, it had CN¥279.8m in cash and CN¥77.5m in receivables that were due within 12 months. So it can boast CN¥15.9m more liquid assets than total liabilities.
This surplus suggests that Sino Gas Holdings Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sino Gas Holdings Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Importantly, Sino Gas Holdings Group's EBIT fell a jaw-dropping 58% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sino Gas Holdings Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sino Gas Holdings Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Sino Gas Holdings Group's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that Sino Gas Holdings Group has net cash of CN¥18.1m, as well as more liquid assets than liabilities. So while Sino Gas Holdings Group does not have a great balance sheet, it's certainly not too bad. Over time, share prices tend to follow earnings per share, so if you're interested in Sino Gas Holdings Group, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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