SomnoMed (ASX:SOM) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that SomnoMed Limited (ASX:SOM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SomnoMed

How Much Debt Does SomnoMed Carry?

The image below, which you can click on for greater detail, shows that at June 2022 SomnoMed had debt of AU$6.89m, up from AU$2.35m in one year. But on the other hand it also has AU$15.6m in cash, leading to a AU$8.75m net cash position.

A Look At SomnoMed's Liabilities

The latest balance sheet data shows that SomnoMed had liabilities of AU$23.8m due within a year, and liabilities of AU$6.53m falling due after that. Offsetting this, it had AU$15.6m in cash and AU$9.20m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$5.46m.

Given SomnoMed has a market capitalization of AU$115.0m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, 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 wasn't profitable at an EBIT level, but managed to grow its revenue by 16%, to AU$73m. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is SomnoMed?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months SomnoMed lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through AU$6.9m of cash and made a loss of AU$4.4m. With only AU$8.75m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. To that end, you should be aware of the 1 warning sign we've spotted with SomnoMed .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.