Is Sensys Gatso Group (STO:SENS) 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 note that Sensys Gatso Group AB (publ) (STO:SENS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sensys Gatso Group

What Is Sensys Gatso Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Sensys Gatso Group had kr57.6m of debt in March 2023, down from kr72.8m, one year before. But it also has kr71.8m in cash to offset that, meaning it has kr14.3m net cash.

How Healthy Is Sensys Gatso Group's Balance Sheet?

We can see from the most recent balance sheet that Sensys Gatso Group had liabilities of kr133.3m falling due within a year, and liabilities of kr66.9m due beyond that. On the other hand, it had cash of kr71.8m and kr47.1m worth of receivables due within a year. So it has liabilities totalling kr81.2m more than its cash and near-term receivables, combined.

Given Sensys Gatso Group has a market capitalization of kr958.6m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sensys Gatso Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Sensys Gatso Group's EBIT fell a jaw-dropping 73% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sensys Gatso 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sensys Gatso Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Considering the last three years, Sensys Gatso Group actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

We could understand if investors are concerned about Sensys Gatso Group's liabilities, but we can be reassured by the fact it has has net cash of kr14.3m. Despite its cash we think that Sensys Gatso Group seems to struggle to grow its EBIT, so we are wary of the stock. 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. For example - Sensys Gatso Group has 1 warning sign we think you should be aware of.

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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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.