Is Steel Connect (NASDAQ:STCN) 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.' 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. We can see that Steel Connect, Inc. (NASDAQ:STCN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Steel Connect

How Much Debt Does Steel Connect Carry?

As you can see below, at the end of April 2023, Steel Connect had US$11.6m of debt, up from US$10.6m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$62.7m in cash, so it actually has US$51.2m net cash.

A Look At Steel Connect's Liabilities

According to the last reported balance sheet, Steel Connect had liabilities of US$80.3m due within 12 months, and liabilities of US$38.4m due beyond 12 months. Offsetting this, it had US$62.7m in cash and US$37.6m in receivables that were due within 12 months. So it has liabilities totalling US$18.3m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Steel Connect is worth US$61.3m, 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. While it does have liabilities worth noting, Steel Connect also has more cash than debt, so we're pretty confident it can manage its debt safely.

Notably, Steel Connect made a loss at the EBIT level, last year, but improved that to positive EBIT of US$7.9m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Steel Connect'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Steel Connect 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. Happily for any shareholders, Steel Connect actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Steel Connect's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$51.2m. The cherry on top was that in converted 119% of that EBIT to free cash flow, bringing in US$9.5m. So we don't have any problem with Steel Connect's use of debt. 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. For example - Steel Connect has 2 warning signs we think you should be aware of.

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.