Is Smith-Midland (NASDAQ:SMID) using too much debt?

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Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. Like many other companies Smith-Midland Corporation (NASDAQ:SMID) uses debt. But does this debt worry shareholders?

Why is debt risky?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Smith-Midland

What is Smith-Midland’s debt?

As you can see below, Smith-Midland had US$6.72 million in debt as of June 2022, up from US$7.21 million the previous year. However, his balance sheet shows that he holds $12.4 million in cash, so he actually has $5.71 million in net cash.

NasdaqCM: Historical SMID Debt-to-Equity Ratio September 14, 2022

How strong is Smith-Midland’s balance sheet?

We can see from the most recent balance sheet that Smith-Midland had liabilities of US$11.5 million due in one year and liabilities of US$10.7 million beyond. On the other hand, it had liquidities of 12.4 million dollars and 13.5 million dollars of receivables at less than one year. So he actually has 3.67 million US dollars After liquid assets than total liabilities.

This short-term liquidity is a sign that Smith-Midland could probably service its debt easily, as its balance sheet is far from stretched. Simply put, the fact that Smith-Midland has more cash than debt is arguably a good indication that it can safely manage its debt.

Its low leverage may become crucial for Smith-Midland if management cannot prevent a repeat of the 76% reduction in EBIT over the past year. When it comes to paying off debt, lower income is no more helpful than sugary sodas for your health. The balance sheet is clearly the area to focus on when analyzing debt. But it is Smith-Midland’s earnings that will influence the balance sheet going forward. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. Although Smith-Midland has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how fast it’s growing. builds (or erodes) cash balance. Over the past three years, Smith-Midland has recorded free cash flow of 26% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.

Summary

While it’s always a good idea to investigate a company’s debt, in this case Smith-Midland has $5.71 million in net cash and a decent balance sheet. So we have no problem with Smith-Midland’s use of debt. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 1 warning sign we spotted with Smith-Midland.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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