Is Spirit Technology Solutions (ASX:ST1) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Spirit Technology Solutions Ltd (ASX:ST1) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Spirit Technology Solutions

How Much Debt Does Spirit Technology Solutions Carry?

As you can see below, at the end of June 2022, Spirit Technology Solutions had AU$13.0m of debt, up from AU$10.0m a year ago. Click the image for more detail. However, it does have AU$11.7m in cash offsetting this, leading to net debt of about AU$1.27m.

How Healthy Is Spirit Technology Solutions' Balance Sheet?

We can see from the most recent balance sheet that Spirit Technology Solutions had liabilities of AU$43.2m falling due within a year, and liabilities of AU$20.9m due beyond that. On the other hand, it had cash of AU$11.7m and AU$12.8m worth of receivables due within a year. So its liabilities total AU$39.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of AU$39.9m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. 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.

Over 12 months, Spirit Technology Solutions reported revenue of AU$135m, which is a gain of 32%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Spirit Technology Solutions's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at AU$1.6m. 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. Another cause for caution is that is bled AU$767k in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be 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. For example - Spirit Technology Solutions has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.