We Think Structural Monitoring Systems (ASX:SMN) Has A Fair Chunk Of Debt

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. As with many other companies Structural Monitoring Systems Plc (ASX:SMN) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Structural Monitoring Systems

How Much Debt Does Structural Monitoring Systems Carry?

As you can see below, at the end of December 2023, Structural Monitoring Systems had AU$5.49m of debt, up from AU$5.14m a year ago. Click the image for more detail. However, because it has a cash reserve of AU$1.50m, its net debt is less, at about AU$3.99m.

How Strong Is Structural Monitoring Systems' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Structural Monitoring Systems had liabilities of AU$9.03m due within 12 months and liabilities of AU$8.39m due beyond that. On the other hand, it had cash of AU$1.50m and AU$3.18m worth of receivables due within a year. So it has liabilities totalling AU$12.7m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Structural Monitoring Systems is worth AU$52.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Structural Monitoring Systems's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Structural Monitoring Systems reported revenue of AU$26m, which is a gain of 34%, although it did not report any earnings before interest and tax. 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$1.6m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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$978k of cash over the last year. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Structural Monitoring Systems that you should be aware of before investing here.

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.