Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Starcom plc (LON: STAR) uses debt. But should shareholders be concerned about its use of debt?
When Is Debt a Problem?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first consider both liquidity and debt levels.
See our latest review for Starcom
What is Starcom’s debt?
As you can see below, at the end of June 2021, Starcom was in debt of $ 2.19 million, up from $ 1.21 million a year ago. Click on the image for more details. However, he also had $ 476.0,000 in cash, so his net debt is $ 1.72 million.
Is Starcom’s track record healthy?
According to the latest published balance sheet, Starcom had a liability of US $ 3.39 million due within 12 months and a liability of US $ 738.0,000 due beyond 12 months. On the other hand, he had cash of US $ 476.0k and US $ 808.0k in receivables due within one year. Its liabilities therefore total $ 2.84 million more than the combination of its cash and short-term receivables.
This shortfall isn’t that big of a deal as Starcom is worth $ 5.35 million, so it could probably raise enough capital to consolidate its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay your debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But you can’t look at debt in isolation; since Starcom will need revenue to pay off this debt. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Over 12 months, Starcom recorded a loss in EBIT and saw its revenue fall to US $ 5.0 million, a decrease of 18%. This is not what we hope to see.
While Starcom’s drop in revenue is about as comforting as a wet blanket, its earnings before interest and taxes (EBIT) can be said to be even less attractive. Its EBIT loss was US $ 1.6 million. When we look at this and recall the liabilities on its balance sheet, versus the cash flow, it seems unwise to us that the company has debt. Quite frankly, we believe the record is far from up to par, although it could improve over time. Another reason to be cautious is that US $ 677k of negative free cash flow over the past twelve months is being bled. In short, it is a really risky action. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. We have identified 5 warning signs with Starcom (at least 2 which are not too suitable for us), and understanding them should be part of your investment process.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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