Here's Why Spirit Technology Solutions (ASX:ST1) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Spirit Technology Solutions Ltd. (ASX:ST1) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Spirit Technology Solutions

How Much Debt Does Spirit Technology Solutions Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Spirit Technology Solutions had debt of AU$5.27m, up from AU$2.99m in one year. However, its balance sheet shows it holds AU$12.9m in cash, so it actually has AU$7.63m net cash.

How Healthy Is Spirit Technology Solutions' Balance Sheet?

According to the last reported balance sheet, Spirit Technology Solutions had liabilities of AU$33.4m due within 12 months, and liabilities of AU$11.1m due beyond 12 months. On the other hand, it had cash of AU$12.9m and AU$12.8m worth of receivables due within a year. So its liabilities total AU$18.8m more than the combination of its cash and short-term receivables.

Since publicly traded Spirit Technology Solutions shares are worth a total of AU$191.6m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Spirit Technology Solutions also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Spirit Technology Solutions made a loss at the EBIT level, last year, but improved that to positive EBIT of AU$209k in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Spirit Technology Solutions 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Spirit Technology Solutions may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Spirit Technology Solutions actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Spirit Technology Solutions's liabilities, but we can be reassured by the fact it has has net cash of AU$7.63m. And it impressed us with free cash flow of AU$1.5m, being 709% of its EBIT. So we don't have any problem with Spirit Technology Solutions's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Spirit Technology Solutions .

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. 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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