The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Sypris Solutions, Inc. (NASDAQ:SYPR) does carry debt. But the real question is whether this debt is making the company risky.
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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Sypris Solutions's Net Debt?
As you can see below, Sypris Solutions had US$7.53m of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$7.49m, its net debt is less, at about US$40.0k.
A Look At Sypris Solutions' Liabilities
We can see from the most recent balance sheet that Sypris Solutions had liabilities of US$38.9m falling due within a year, and liabilities of US$17.8m due beyond that. Offsetting this, it had US$7.49m in cash and US$11.8m in receivables that were due within 12 months. So it has liabilities totalling US$37.4m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$43.8m, so it does suggest shareholders should keep an eye on Sypris Solutions' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, Sypris Solutions has virtually no net debt, so it's fair to say it does not have a heavy debt load!
We also note that Sypris Solutions improved its EBIT from a last year's loss to a positive US$2.7m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sypris Solutions's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Sypris Solutions saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
We'd go so far as to say Sypris Solutions's conversion of EBIT to free cash flow was disappointing. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. Overall, we think it's fair to say that Sypris Solutions has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. For example, we've discovered 3 warning signs for Sypris Solutions (1 shouldn't be ignored!) that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
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