Is L.S. Starrett (NYSE:SCX) Using Debt Sensibly?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies The L.S. Starrett Company (NYSE:SCX) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 L.S. Starrett

How Much Debt Does L.S. Starrett Carry?

As you can see below, L.S. Starrett had US$25.4m of debt at March 2021, down from US$28.5m a year prior. On the flip side, it has US$11.2m in cash leading to net debt of about US$14.2m.

How Healthy Is L.S. Starrett's Balance Sheet?

We can see from the most recent balance sheet that L.S. Starrett had liabilities of US$33.6m falling due within a year, and liabilities of US$86.3m due beyond that. Offsetting these obligations, it had cash of US$11.2m as well as receivables valued at US$34.5m due within 12 months. So its liabilities total US$74.2m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's US$62.3m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since L.S. Starrett will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year L.S. Starrett had a loss before interest and tax, and actually shrunk its revenue by 8.7%, to US$201m. We would much prefer see growth.

Caveat Emptor

Over the last twelve months L.S. Starrett produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$7.9m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$1.5m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for L.S. Starrett (1 is a bit unpleasant!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.
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