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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. We can see that Zicom Group Limited (ASX:ZGL) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Zicom Group
What Is Zicom Group's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Zicom Group had S$22.2m of debt, an increase on S$19.1m, over one year. However, it also had S$15.1m in cash, and so its net debt is S$7.03m.
How Healthy Is Zicom Group's Balance Sheet?
We can see from the most recent balance sheet that Zicom Group had liabilities of S$50.8m falling due within a year, and liabilities of S$4.57m due beyond that. Offsetting this, it had S$15.1m in cash and S$21.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$18.8m.
Given this deficit is actually higher than the company's market capitalization of S$16.5m, we think shareholders really should watch Zicom Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.