The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Saga Communications, Inc. (NASDAQ:SGA) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Saga Communications Carry?
You can click the graphic below for the historical numbers, but it shows that Saga Communications had US$10.0m of debt in June 2019, down from US$25.0m, one year before. However, its balance sheet shows it holds US$38.5m in cash, so it actually has US$28.5m net cash.
A Look At Saga Communications's Liabilities
According to the last reported balance sheet, Saga Communications had liabilities of US$17.6m due within 12 months, and liabilities of US$41.0m due beyond 12 months. Offsetting this, it had US$38.5m in cash and US$20.8m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.
Having regard to Saga Communications's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$172.8m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Saga Communications has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Saga Communications has increased its EBIT by 3.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Saga Communications's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Saga Communications 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. In the last three years, Saga Communications created free cash flow amounting to 13% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to investigate a company's debt, in this case Saga Communications has US$29m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 3.8% in the last twelve months. So we don't have any problem with Saga Communications's use of debt. Given Saga Communications has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.
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.
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