Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, SmileDirectClub, Inc. (NASDAQ:SDC) does carry debt. But is this debt a concern to shareholders?
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. 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. 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.
What Is SmileDirectClub’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 SmileDirectClub had US$211.8m of debt, an increase on US$151, over one year. However, it does have US$547.6m in cash offsetting this, leading to net cash of US$335.8m.
How Strong Is SmileDirectClub’s Balance Sheet?
According to the last reported balance sheet, SmileDirectClub had liabilities of US$225.8m due within 12 months, and liabilities of US$234.9m due beyond 12 months. Offsetting these obligations, it had cash of US$547.6m as well as receivables valued at US$224.4m due within 12 months. So it actually has US$311.3m more liquid assets than total liabilities.
This surplus suggests that SmileDirectClub has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SmileDirectClub boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine SmileDirectClub’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, SmileDirectClub reported revenue of US$643m, which is a gain of 93%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is SmileDirectClub?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that SmileDirectClub had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of US$312m and booked a US$114m accounting loss. But at least it has US$335.8m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, SmileDirectClub may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. For instance, we’ve identified 1 warning sign for SmileDirectClub that you should be aware of.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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