Is Sempra (NYSE: SRE) a risky investment?

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Howard Marks put it well when he said that, rather than worrying about stock price volatility, “The possibility of permanent loss is the risk I worry about … and every investor practice that I know is worried. ” So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. Above all, Sempra (NYSE: SRE) is in debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we think of a business’s use of debt, we first look at cash flow and debt together.

Check out our latest analysis for Sempra

How much debt does Sempra have?

The image below, which you can click for more details, shows that in September 2021, Sempra had $ 26.4 billion in debt, up from $ 24.6 billion in a year. However, he also had $ 873.0 million in cash, so his net debt is $ 25.5 billion.

NYSE Debt to Equity History: SRE November 8, 2021

A look at Sempra’s responsibilities

According to the latest published balance sheet, Sempra had liabilities of US $ 12.9 billion due within 12 months and liabilities of US $ 32.9 billion due beyond 12 months. In return, he had $ 873.0 million in cash and $ 2.01 billion in receivables due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 43.0 billion.

When you consider that this deficiency exceeds the company’s huge US $ 40.7 billion market cap, you might well be inclined to take a close look at the balance sheet. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.

We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

Sempra has a rather high debt to EBITDA ratio of 5.9, which suggests significant leverage. However, its interest coverage of 2.7 is reasonably strong, which is a good sign. Even more troubling is the fact that Sempra actually allowed its EBIT to decline 5.6% over the past year. If it continues like this, paying off debt will be like running on a treadmill – a lot of effort for little progress. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future profits, more than anything, that will determine Sempra’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years, Sempra has burned a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.

Our point of view

At first glance, Sempra’s net debt to EBITDA left us hesitant about the title, and its conversion from EBIT to free cash flow was no more appealing than the single empty restaurant on the most night. responsible for the year. And besides, his total passive level also fails to inspire confidence. It should also be noted that companies in the integrated utility sector like Sempra generally use debt without a problem. We’re pretty clear that we see Sempra as really pretty risky, because of the health of its balance sheet. For this reason, we are quite cautious on the stock, and we believe that shareholders should closely monitor its liquidity. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we have identified 5 warning signs for Sempra (1 makes us a little uncomfortable) you should be aware of this.

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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