Is STS Group (ETR:SF3) Using Too Much 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.' 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 note that STS Group AG (ETR:SF3) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for STS Group

What Is STS Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 STS Group had debt of €27.9m, up from €26.1m in one year. However, its balance sheet shows it holds €32.7m in cash, so it actually has €4.80m net cash.

How Healthy Is STS Group's Balance Sheet?

We can see from the most recent balance sheet that STS Group had liabilities of €155.5m falling due within a year, and liabilities of €63.7m due beyond that. Offsetting these obligations, it had cash of €32.7m as well as receivables valued at €53.8m due within 12 months. So it has liabilities totalling €132.7m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the €26.7m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, STS Group would likely require a major re-capitalisation if it had to pay its creditors today. Given that STS Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

We also note that STS Group improved its EBIT from a last year's loss to a positive €8.8m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if STS Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While STS Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last year, STS Group reported free cash flow worth 2.3% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

Although STS Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €4.80m. Unfortunately, though, both its struggle level of total liabilities and its interest cover leave us concerned about STS Group So despite the cash, we do think it carries some risks. 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. Be aware that STS Group is showing 1 warning sign in our investment analysis , you should know about...

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.