David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Zicom Group Limited (ASX:ZGL) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.
How Much Debt Does Zicom Group Carry?
The image below, which you can click on for greater detail, shows that Zicom Group had debt of S$19.5m at the end of June 2021, a reduction from S$34.7m over a year. But it also has S$20.3m in cash to offset that, meaning it has S$793.0k net cash.
A Look At Zicom Group's Liabilities
Zooming in on the latest balance sheet data, we can see that Zicom Group had liabilities of S$46.5m due within 12 months and liabilities of S$13.2m due beyond that. On the other hand, it had cash of S$20.3m and S$21.5m worth of receivables due within a year. So its liabilities total S$17.9m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of S$23.6m, so it does suggest shareholders should keep an eye on Zicom Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Zicom Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that Zicom Group's EBIT was down 44% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Zicom Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Zicom 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. Happily for any shareholders, Zicom Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Although Zicom Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of S$793.0k. The cherry on top was that in converted 701% of that EBIT to free cash flow, bringing in S$26m. So although we see some areas for improvement, we're not too worried about Zicom Group's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Zicom Group , and understanding them should be part of your investment process.
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.
If you decide to trade Zicom Group, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.