Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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. We can see that STAAR Surgical Company (NASDAQ:STAA) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is STAAR Surgical's Net Debt?
As you can see below, STAAR Surgical had US$2.34m of debt at September 2019, down from US$6.18m a year prior. However, it does have US$112.3m in cash offsetting this, leading to net cash of US$110.0m.
How Healthy Is STAAR Surgical's Balance Sheet?
According to the last reported balance sheet, STAAR Surgical had liabilities of US$30.0m due within 12 months, and liabilities of US$13.4m due beyond 12 months. Offsetting these obligations, it had cash of US$112.3m as well as receivables valued at US$32.4m due within 12 months. So it actually has US$101.4m more liquid assets than total liabilities.
This short term liquidity is a sign that STAAR Surgical could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that STAAR Surgical has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that STAAR Surgical grew its EBIT by 155% over twelve months. That boost will make it even easier to pay down debt going forward. 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 STAAR Surgical'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While STAAR Surgical 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. Happily for any shareholders, STAAR Surgical actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case STAAR Surgical has US$110.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$11m, being 137% of its EBIT. When it comes to STAAR Surgical's debt, we sufficiently relaxed that our mind turns to the jacuzzi. We'd be very excited to see if STAAR Surgical insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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