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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Smart Sand, Inc. (NASDAQ:SND) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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, 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 Smart Sand

What Is Smart Sand's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Smart Sand had debt of US$14.2m, up from US$12.0m in one year. However, it also had US$6.26m in cash, and so its net debt is US$7.90m.

How Strong Is Smart Sand's Balance Sheet?

The latest balance sheet data shows that Smart Sand had liabilities of US$39.1m due within a year, and liabilities of US$59.9m falling due after that. Offsetting this, it had US$6.26m in cash and US$31.1m in receivables that were due within 12 months. So its liabilities total US$61.6m more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of US$92.3m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

Smart Sand has a very low debt to EBITDA ratio of 0.26 so it is strange to see weak interest coverage, with last year's EBIT being only 0.82 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Importantly, Smart Sand's EBIT fell a jaw-dropping 86% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Smart Sand'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Happily for any shareholders, Smart Sand actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

While Smart Sand's EBIT growth rate has us nervous. To wit both its conversion of EBIT to free cash flow and net debt to EBITDA were encouraging signs. Taking the abovementioned factors together we do think Smart Sand's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 instance, we've identified 5 warning signs for Smart Sand that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.