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 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 SmileDirectClub, Inc. (NASDAQ:SDC) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is SmileDirectClub's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 SmileDirectClub had debt of US$211.8m, up from US$150.5m in one year. But it also has US$547.6m in cash to offset that, meaning it has US$335.8m net cash.
How Healthy Is SmileDirectClub's Balance Sheet?
The latest balance sheet data shows that SmileDirectClub had liabilities of US$225.8m due within a year, and liabilities of US$234.9m falling due after that. Offsetting these obligations, it had cash of US$547.6m as well as receivables valued at US$224.4m due within 12 months. So it actually has US$311.3m more liquid assets than total liabilities.
This short term liquidity is a sign that SmileDirectClub could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that SmileDirectClub has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine SmileDirectClub'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.
In the last year SmileDirectClub wasn't profitable at an EBIT level, but managed to grow its revenue by 93%, to US$643m. With any luck the company will be able to grow its way to profitability.
So How Risky Is SmileDirectClub?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year SmileDirectClub had negative earnings before interest and tax (EBIT), truth be told. Indeed, in that time it burnt through US$312m of cash and made a loss of US$114m. But at least it has US$335.8m on the balance sheet to spend on growth, near-term. SmileDirectClub's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for SmileDirectClub that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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