Is Superior Drilling Products (NYSEMKT:SDPI) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Superior Drilling Products, Inc. (NYSEMKT:SDPI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Superior Drilling Products

What Is Superior Drilling Products's Net Debt?

As you can see below, Superior Drilling Products had US$2.85m of debt at December 2020, down from US$7.95m a year prior. However, because it has a cash reserve of US$1.96m, its net debt is less, at about US$886.9k.

How Healthy Is Superior Drilling Products' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Superior Drilling Products had liabilities of US$3.17m due within 12 months and liabilities of US$5.65m due beyond that. Offsetting this, it had US$1.96m in cash and US$1.35m in receivables that were due within 12 months. So it has liabilities totalling US$5.51m more than its cash and near-term receivables, combined.

Superior Drilling Products has a market capitalization of US$25.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 Superior Drilling Products'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.

In the last year Superior Drilling Products had a loss before interest and tax, and actually shrunk its revenue by 45%, to US$10m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Superior Drilling Products's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$3.8m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$3.4m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Superior Drilling Products , and understanding them should be part of your investment process.

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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