Here's Why Starcom (LON:STAR) Can Afford Some 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Starcom plc (LON:STAR) 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Starcom

What Is Starcom's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Starcom had debt of US$1.95m, up from US$1.05m in one year. However, it does have US$264.0k in cash offsetting this, leading to net debt of about US$1.68m.

How Strong Is Starcom's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Starcom had liabilities of US$3.72m due within 12 months and liabilities of US$539.0k due beyond that. Offsetting this, it had US$264.0k in cash and US$1.21m in receivables that were due within 12 months. So its liabilities total US$2.78m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$3.86m, so it does suggest shareholders should keep an eye on Starcom's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Starcom's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Starcom made a loss at the EBIT level, and saw its revenue drop to US$5.0m, which is a fall of 26%. To be frank that doesn't bode well.

Caveat Emptor

While Starcom's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping US$1.8m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$688k in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Starcom (of which 2 are significant!) you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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