Stock Analysis

Smart Sand (NASDAQ:SND) Has A Somewhat Strained Balance Sheet

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NasdaqGS:SND
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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 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. We can see that Smart Sand, Inc. (NASDAQ:SND) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Smart Sand

What Is Smart Sand's Net Debt?

As you can see below, Smart Sand had US$29.8m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$11.0m in cash offsetting this, leading to net debt of about US$18.8m.

debt-equity-history-analysis
NasdaqGS:SND Debt to Equity History January 15th 2021

How Healthy Is Smart Sand's Balance Sheet?

According to the last reported balance sheet, Smart Sand had liabilities of US$41.0m due within 12 months, and liabilities of US$104.9m due beyond 12 months. Offsetting this, it had US$11.0m in cash and US$75.3m in receivables that were due within 12 months. So its liabilities total US$59.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$87.2m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.44 times EBITDA, Smart Sand is arguably pretty conservatively geared. And it boasts interest cover of 8.5 times, which is more than adequate. The modesty of its debt load may become crucial for Smart Sand if management cannot prevent a repeat of the 66% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Smart Sand can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Smart Sand saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Smart Sand's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Smart Sand's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 6 warning signs for Smart Sand you should be aware of, and 1 of them shouldn't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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