Is SSH Group (ASX:SSH) Using Too Much Debt?

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. Importantly, SSH Group Limited (ASX:SSH) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for SSH Group

What Is SSH Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 SSH Group had AU$5.49m of debt, an increase on AU$4.91m, over one year. However, because it has a cash reserve of AU$2.60m, its net debt is less, at about AU$2.89m.

How Healthy Is SSH Group's Balance Sheet?

According to the last reported balance sheet, SSH Group had liabilities of AU$16.5m due within 12 months, and liabilities of AU$19.3m due beyond 12 months. Offsetting this, it had AU$2.60m in cash and AU$6.78m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$26.5m.

This deficit casts a shadow over the AU$5.14m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, SSH Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 0.43 times EBITDA, it is initially surprising to see that SSH Group's EBIT has low interest coverage of 1.3 times. So one way or the other, it's clear the debt levels are not trivial. We also note that SSH Group improved its EBIT from a last year's loss to a positive AU$3.0m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SSH Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, SSH Group actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both SSH Group's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making SSH Group stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with SSH Group .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.