Health Check: How Prudently Does SomnoMed (ASX:SOM) Use Debt?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies SomnoMed Limited (ASX:SOM) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SomnoMed

What Is SomnoMed's Net Debt?

As you can see below, SomnoMed had AU$2.37m of debt at December 2020, down from AU$3.36m a year prior. However, its balance sheet shows it holds AU$25.1m in cash, so it actually has AU$22.7m net cash.

How Strong Is SomnoMed's Balance Sheet?

According to the last reported balance sheet, SomnoMed had liabilities of AU$15.5m due within 12 months, and liabilities of AU$9.80m due beyond 12 months. On the other hand, it had cash of AU$25.1m and AU$10.7m worth of receivables due within a year. So it can boast AU$10.4m more liquid assets than total liabilities.

This surplus suggests that SomnoMed has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, SomnoMed 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 ultimately the future profitability of the business will decide if SomnoMed can strengthen its balance sheet over time. 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 SomnoMed had a loss before interest and tax, and actually shrunk its revenue by 13%, to AU$55m. We would much prefer see growth.

So How Risky Is SomnoMed?

While SomnoMed lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow AU$4.7m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting SomnoMed insider transactions.

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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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. 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.
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