Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Saga Communications, Inc. (NASDAQ:SGA) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Saga Communications Carry?
As you can see below, Saga Communications had US$10.0m of debt at September 2019, down from US$20.0m a year prior. But on the other hand it also has US$41.1m in cash, leading to a US$31.1m net cash position.
How Strong Is Saga Communications's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Saga Communications had liabilities of US$17.2m due within 12 months and liabilities of US$41.4m due beyond that. Offsetting this, it had US$41.1m in cash and US$19.7m in receivables that were due within 12 months. So it actually has US$2.13m more liquid assets than total liabilities.
Having regard to Saga Communications's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$184.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Saga Communications boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Saga Communications grew its EBIT by 2.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Saga Communications's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Saga Communications 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. In the last three years, Saga Communications created free cash flow amounting to 9.6% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Saga Communications has net cash of US$31.1m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 2.1% in the last twelve months. So we don't have any problem with Saga Communications's use of debt. 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. Be aware that Saga Communications is showing 2 warning signs in our investment analysis , you should know about...
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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