Is Standard Motor Products (NYSE:SMP) Using Too Much Debt?
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 Standard Motor Products, Inc. (NYSE:SMP) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Standard Motor Products
What Is Standard Motor Products's Net Debt?
As you can see below, Standard Motor Products had US$12.1m of debt at September 2020, down from US$83.6m a year prior. But on the other hand it also has US$16.8m in cash, leading to a US$4.68m net cash position.
How Strong Is Standard Motor Products' Balance Sheet?
We can see from the most recent balance sheet that Standard Motor Products had liabilities of US$303.8m falling due within a year, and liabilities of US$102.3m due beyond that. Offsetting this, it had US$16.8m in cash and US$238.0m in receivables that were due within 12 months. So it has liabilities totalling US$151.3m more than its cash and near-term receivables, combined.
Of course, Standard Motor Products has a market capitalization of US$958.0m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Standard Motor Products also has more cash than debt, so we're pretty confident it can manage its debt safely.
Fortunately, Standard Motor Products grew its EBIT by 3.0% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Standard Motor Products can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Standard Motor Products 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. Over the most recent three years, Standard Motor Products recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
Although Standard Motor Products's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$4.68m. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in US$95m. So is Standard Motor Products's debt a risk? It doesn't seem so to us. 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 Standard Motor Products is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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