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.' 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, Swift Media Limited (ASX:SW1) does carry debt. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Swift Media's Debt?
The chart below, which you can click on for greater detail, shows that Swift Media had AU$7.08m in debt in December 2020; about the same as the year before. On the flip side, it has AU$6.95m in cash leading to net debt of about AU$132.6k.
A Look At Swift Media's Liabilities
According to the last reported balance sheet, Swift Media had liabilities of AU$11.1m due within 12 months, and liabilities of AU$9.37m due beyond 12 months. On the other hand, it had cash of AU$6.95m and AU$3.50m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$10.0m.
This deficit is considerable relative to its market capitalization of AU$10.4m, so it does suggest shareholders should keep an eye on Swift Media's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, Swift Media has virtually no net debt, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Swift Media'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.
In the last year Swift Media had a loss before interest and tax, and actually shrunk its revenue by 9.3%, to AU$22m. We would much prefer see growth.
Over the last twelve months Swift Media produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable AU$9.0m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through AU$1.6m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Swift Media (at least 2 which are potentially serious) , and understanding them should be part of your investment process.
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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