SmileDirectClub (NASDAQ:SDC) Is Carrying A Fair Bit Of Debt

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.' 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. Importantly, SmileDirectClub, Inc. (NASDAQ:SDC) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SmileDirectClub

What Is SmileDirectClub's Debt?

As you can see below, at the end of March 2021, SmileDirectClub had US$726.1m of debt, up from US$191.7m a year ago. Click the image for more detail. However, it does have US$434.5m in cash offsetting this, leading to net debt of about US$291.6m.

How Strong Is SmileDirectClub's Balance Sheet?

We can see from the most recent balance sheet that SmileDirectClub had liabilities of US$170.9m falling due within a year, and liabilities of US$761.3m due beyond that. Offsetting these obligations, it had cash of US$434.5m as well as receivables valued at US$225.4m due within 12 months. So its liabilities total US$272.2m more than the combination of its cash and short-term receivables.

Since publicly traded SmileDirectClub shares are worth a total of US$2.63b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 SmileDirectClub can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year SmileDirectClub had a loss before interest and tax, and actually shrunk its revenue by 14%, to US$660m. We would much prefer see growth.

Caveat Emptor

Not only did SmileDirectClub's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$115m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$134m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. For instance, we've identified 1 warning sign for SmileDirectClub that 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.

When trading SmileDirectClub or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.