Does Spirit Technology Solutions (ASX:ST1) Have A Healthy Balance Sheet?

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 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. Importantly, Spirit Technology Solutions Ltd (ASX:ST1) does carry debt. But the more important question is: how much risk is that debt creating?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Spirit Technology Solutions

What Is Spirit Technology Solutions's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Spirit Technology Solutions had AU$10.0m of debt, an increase on AU$3.27m, over one year. However, because it has a cash reserve of AU$8.49m, its net debt is less, at about AU$1.51m.

How Strong Is Spirit Technology Solutions' Balance Sheet?

The latest balance sheet data shows that Spirit Technology Solutions had liabilities of AU$43.0m due within a year, and liabilities of AU$19.5m falling due after that. On the other hand, it had cash of AU$8.49m and AU$16.0m worth of receivables due within a year. So it has liabilities totalling AU$38.0m more than its cash and near-term receivables, combined.

Spirit Technology Solutions has a market capitalization of AU$160.8m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Carrying virtually no net debt, Spirit Technology Solutions has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Spirit Technology Solutions's low debt to EBITDA ratio of 0.20 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Spirit Technology Solutions made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$3.0m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Spirit Technology Solutions's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Considering the last year, Spirit Technology Solutions actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Spirit Technology Solutions's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But its net debt to EBITDA tells a very different story, and suggests some resilience. We think that Spirit Technology Solutions's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Spirit Technology Solutions that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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.

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