Seamless Distribution Systems (STO:SDS) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Seamless Distribution Systems AB (publ) (STO:SDS) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Seamless Distribution Systems

How Much Debt Does Seamless Distribution Systems Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Seamless Distribution Systems had debt of kr49.5m, up from kr40.3m in one year. On the flip side, it has kr13.5m in cash leading to net debt of about kr36.0m.

A Look At Seamless Distribution Systems's Liabilities

According to the last reported balance sheet, Seamless Distribution Systems had liabilities of kr93.8m due within 12 months, and liabilities of kr64.7m due beyond 12 months. On the other hand, it had cash of kr13.5m and kr43.1m worth of receivables due within a year. So its liabilities total kr101.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Seamless Distribution Systems is worth kr422.3m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Looking at its net debt to EBITDA of 0.83 and interest cover of 4.5 times, it seems to us that Seamless Distribution Systems is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, Seamless Distribution Systems is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 379% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Seamless Distribution Systems will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, Seamless Distribution Systems burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Seamless Distribution Systems is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to grow its EBIT is pretty flash. Looking at all this data makes us feel a little cautious about Seamless Distribution Systems's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Like risks, for instance. Every company has them, and we've spotted 6 warning signs for Seamless Distribution Systems (of which 2 don't sit too well with us!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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