Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.' So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. As with many other companies Alarm.com Holdings, Inc. (NASDAQ:ALRM) makes use of debt. But should shareholders be worried about its use of debt?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Alarm.com Holdings
The image below, which you can click on for greater detail, shows that at June 2022 Alarm.com Holdings had debt of US$488.8m, up from US$416.9m in one year. But it also has US$643.4m in cash to offset that, meaning it has US$154.6m net cash.
We can see from the most recent balance sheet that Alarm.com Holdings had liabilities of US$141.4m falling due within a year, and liabilities of US$536.7m due beyond that. Offsetting these obligations, it had cash of US$643.4m as well as receivables valued at US$108.3m due within 12 months. So it actually has US$73.5m more liquid assets than total liabilities.
This surplus suggests that Alarm.com Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Alarm.com Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Alarm.com Holdings's saving grace is its low debt levels, because its EBIT has tanked 23% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Alarm.com Holdings's ability to maintain a healthy balance sheet going forward. 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. Alarm.com Holdings 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, Alarm.com Holdings recorded free cash flow worth a fulsome 80% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Alarm.com Holdings has US$154.6m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$36m, being 80% of its EBIT. So we are not troubled with Alarm.com Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Alarm.com Holdings you should be aware of.
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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Alarm.com Holdings, Inc. provides cloud-based solutions for smart residential and commercial properties in the United States and internationally.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Adequate balance sheet with questionable track record.
Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.
Alarm.com Holdings, Inc. provides cloud-based solutions for smart residential and commercial properties in the United States and internationally.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
Read more about these checks in the individual report sections or in our analysis model.
Adequate balance sheet with questionable track record.
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