Alarm.com Holdings (NASDAQ:ALRM) Could Easily Take On More Debt

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. As with many other companies Alarm.com Holdings, Inc. (NASDAQ:ALRM) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Alarm.com Holdings

How Much Debt Does Alarm.com Holdings Carry?

As you can see below, at the end of June 2021, Alarm.com Holdings had US$416.9m of debt, up from US$112.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$662.7m in cash, so it actually has US$245.8m net cash.

How Healthy Is Alarm.com Holdings' Balance Sheet?

We can see from the most recent balance sheet that Alarm.com Holdings had liabilities of US$104.1m falling due within a year, and liabilities of US$467.9m due beyond that. On the other hand, it had cash of US$662.7m and US$92.6m worth of receivables due within a year. So it can boast US$183.3m more liquid assets than total liabilities.

This surplus suggests that Alarm.com Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Alarm.com Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Alarm.com Holdings grew its EBIT by 14% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alarm.com Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Alarm.com Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Alarm.com Holdings generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$245.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$83m, being 92% of its EBIT. So we don't think Alarm.com Holdings's use of debt is 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. Be aware that Alarm.com Holdings is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.

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.

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