Is System1 Group (LON:SYS1) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that System1 Group PLC (LON:SYS1) 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 System1 Group

What Is System1 Group's Net Debt?

As you can see below, System1 Group had UK£2.50m of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds UK£9.06m in cash, so it actually has UK£6.56m net cash.

How Strong Is System1 Group's Balance Sheet?

According to the last reported balance sheet, System1 Group had liabilities of UK£7.73m due within 12 months, and liabilities of UK£1.33m due beyond 12 months. Offsetting this, it had UK£9.06m in cash and UK£5.64m in receivables that were due within 12 months. So it actually has UK£5.65m more liquid assets than total liabilities.

This surplus suggests that System1 Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, System1 Group boasts net cash, so it's fair to say it does not have a heavy debt load! 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 System1 Group'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.

In the last year System1 Group had a loss before interest and tax, and actually shrunk its revenue by 11%, to UK£22m. We would much prefer see growth.

So How Risky Is System1 Group?

While System1 Group lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow UK£3.0k. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with System1 Group (including 1 which is a bit unpleasant) .

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.