Is Science Group (LON:SAG) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Science Group plc (LON:SAG) does use debt in its business. But the real question is whether this debt is making the company risky.

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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Science Group

How Much Debt Does Science Group Carry?

The image below, which you can click on for greater detail, shows that at June 2020 Science Group had debt of UK£17.8m, up from UK£16.8m in one year. But on the other hand it also has UK£22.0m in cash, leading to a UK£4.24m net cash position.

A Look At Science Group's Liabilities

We can see from the most recent balance sheet that Science Group had liabilities of UK£27.7m falling due within a year, and liabilities of UK£22.1m due beyond that. Offsetting this, it had UK£22.0m in cash and UK£9.71m in receivables that were due within 12 months. So it has liabilities totalling UK£18.1m more than its cash and near-term receivables, combined.

Of course, Science Group has a market capitalization of UK£115.2m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Science Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Science Group grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Science Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Science 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. Happily for any shareholders, Science Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Science 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 UK£4.24m. The cherry on top was that in converted 170% of that EBIT to free cash flow, bringing in UK£14m. So we don't think Science Group's use of debt is 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. Case in point: We've spotted 3 warning signs for Science Group you should be aware of, and 2 of them can't be ignored.

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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