Is Alarm.com Holdings (NASDAQ:ALRM) Using Too Much 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. Importantly, Alarm.com Holdings, Inc. (NASDAQ:ALRM) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alarm.com Holdings

What Is Alarm.com Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Alarm.com Holdings had US$492.0m in debt in March 2023; about the same as the year before. But on the other hand it also has US$606.4m in cash, leading to a US$114.4m net cash position.

How Strong Is Alarm.com Holdings' Balance Sheet?

We can see from the most recent balance sheet that Alarm.com Holdings had liabilities of US$161.2m falling due within a year, and liabilities of US$545.1m due beyond that. Offsetting these obligations, it had cash of US$606.4m as well as receivables valued at US$125.9m due within 12 months. So it actually has US$26.0m more liquid assets than total liabilities.

Having regard to Alarm.com Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$2.56b company is short on cash, but still worth keeping an eye on the balance sheet. 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.

On the other hand, Alarm.com Holdings saw its EBIT drop by 7.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Alarm.com Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. 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 puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$114.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$38m, being 92% of its EBIT. So is Alarm.com Holdings's debt a risk? It doesn't seem so to us. 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 2 warning signs for Alarm.com Holdings you should be aware of, and 1 of them is significant.

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.

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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.