David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Strattec Security Corporation (NASDAQ:STRT) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
What Is Strattec Security's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Strattec Security had US$12.0m of debt in March 2022, down from US$16.0m, one year before. However, its balance sheet shows it holds US$16.5m in cash, so it actually has US$4.46m net cash.
How Healthy Is Strattec Security's Balance Sheet?
We can see from the most recent balance sheet that Strattec Security had liabilities of US$80.0m falling due within a year, and liabilities of US$19.3m due beyond that. Offsetting this, it had US$16.5m in cash and US$76.5m in receivables that were due within 12 months. So its liabilities total US$6.33m more than the combination of its cash and short-term receivables.
Of course, Strattec Security has a market capitalization of US$136.2m, 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, Strattec Security also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Strattec Security's EBIT dived 20%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Strattec Security 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Strattec Security 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. Over the last three years, Strattec Security actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Strattec Security's liabilities, but we can be reassured by the fact it has has net cash of US$4.46m. The cherry on top was that in converted 134% of that EBIT to free cash flow, bringing in US$9.6m. So we are not troubled with Strattec Security's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Strattec Security that you should be aware of before investing here.
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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.