Structural Monitoring Systems (ASX:SMN) Is Making Moderate Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Structural Monitoring Systems Plc (ASX:SMN) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 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 Structural Monitoring Systems

What Is Structural Monitoring Systems's Net Debt?

The image below, which you can click on for greater detail, shows that Structural Monitoring Systems had debt of AU$5.14m at the end of December 2022, a reduction from AU$5.86m over a year. However, it does have AU$1.98m in cash offsetting this, leading to net debt of about AU$3.17m.

A Look At Structural Monitoring Systems' Liabilities

We can see from the most recent balance sheet that Structural Monitoring Systems had liabilities of AU$10.2m falling due within a year, and liabilities of AU$8.07m due beyond that. Offsetting these obligations, it had cash of AU$1.98m as well as receivables valued at AU$3.72m due within 12 months. So it has liabilities totalling AU$12.6m more than its cash and near-term receivables, combined.

Of course, Structural Monitoring Systems has a market capitalization of AU$91.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Structural Monitoring Systems will need earnings to service that debt. 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 Structural Monitoring Systems wasn't profitable at an EBIT level, but managed to grow its revenue by 41%, to AU$19m. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Structural Monitoring Systems still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$3.2m 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. Another cause for caution is that is bled AU$4.6m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Structural Monitoring Systems (of which 2 are a bit concerning!) you should know about.

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. 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.