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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Sigma Healthcare Limited (ASX:SIG) does have debt on its balance sheet. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.
See our latest analysis for Sigma Healthcare
How Much Debt Does Sigma Healthcare Carry?
As you can see below, Sigma Healthcare had AU$199.1m of debt at July 2020, down from AU$315.8m a year prior. However, it also had AU$19.9m in cash, and so its net debt is AU$179.2m.
A Look At Sigma Healthcare's Liabilities
The latest balance sheet data shows that Sigma Healthcare had liabilities of AU$677.7m due within a year, and liabilities of AU$40.4m falling due after that. Offsetting this, it had AU$19.9m in cash and AU$362.6m in receivables that were due within 12 months. So its liabilities total AU$335.6m more than the combination of its cash and short-term receivables.
Sigma Healthcare has a market capitalization of AU$611.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sigma Healthcare'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.
In the last year Sigma Healthcare had a loss before interest and tax, and actually shrunk its revenue by 23%, to AU$3.0b. To be frank that doesn't bode well.
Caveat Emptor
Not only did Sigma Healthcare's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost AU$3.7m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of AU$10m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Sigma Healthcare has 1 warning sign we think you should be aware of.
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.
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About ASX:SIG
Sigma Healthcare
Engages in the wholesale distribution of pharmaceutical goods and medical consumables to community pharmacies primarily in Australia.
Exceptional growth potential with flawless balance sheet.
