Is SPAR Group (NASDAQ:SGRP) 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 note that SPAR Group, Inc. (NASDAQ:SGRP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SPAR Group

What Is SPAR Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that SPAR Group had US$16.9m of debt in September 2020, down from US$17.9m, one year before. On the flip side, it has US$15.8m in cash leading to net debt of about US$1.13m.

How Healthy Is SPAR Group's Balance Sheet?

According to the last reported balance sheet, SPAR Group had liabilities of US$47.3m due within 12 months, and liabilities of US$2.90m due beyond 12 months. Offsetting these obligations, it had cash of US$15.8m as well as receivables valued at US$47.4m due within 12 months. So it can boast US$12.9m more liquid assets than total liabilities.

This excess liquidity is a great indication that SPAR Group's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 0.13 times EBITDA, SPAR Group is arguably pretty conservatively geared. And it boasts interest cover of 8.6 times, which is more than adequate. But the bad news is that SPAR Group has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is SPAR Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, SPAR Group recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Happily, SPAR Group's impressive level of total liabilities implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Looking at the bigger picture, we think SPAR Group's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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 5 warning signs for SPAR Group you should be aware of, and 1 of them is concerning.

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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