Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Alarm.com Holdings's Net Debt?
The image below, which you can click on for greater detail, shows that Alarm.com Holdings had debt of US$65.0m at the end of June 2019, a reduction from US$69.0m over a year. But on the other hand it also has US$150.9m in cash, leading to a US$85.9m net cash position.
How Strong Is Alarm.com Holdings's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Alarm.com Holdings had liabilities of US$83.2m due within 12 months and liabilities of US$109.8m due beyond that. On the other hand, it had cash of US$150.9m and US$61.0m worth of receivables due within a year. So it can boast US$18.9m more liquid assets than total liabilities.
This state of affairs indicates that Alarm.com Holdings's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$2.34b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Alarm.com Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Alarm.com Holdings has increased its EBIT by 4.6% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. 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. 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 produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$86m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in US$57m. So is Alarm.com Holdings's debt a risk? It doesn't seem so to us. Another factor that would give us confidence in Alarm.com Holdings would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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