Advertisement

Sangoma Technologies (CVE:STC) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Sangoma Technologies Corporation (CVE:STC) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sangoma Technologies

What Is Sangoma Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sangoma Technologies had CA$21.7m of debt in September 2019, down from CA$24.9m, one year before. But on the other hand it also has CA$33.4m in cash, leading to a CA$11.7m net cash position.

TSXV:STC Historical Debt, February 26th 2020
TSXV:STC Historical Debt, February 26th 2020

How Strong Is Sangoma Technologies's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sangoma Technologies had liabilities of CA$30.7m due within 12 months and liabilities of CA$37.7m due beyond that. On the other hand, it had cash of CA$33.4m and CA$11.0m worth of receivables due within a year. So it has liabilities totalling CA$24.0m more than its cash and near-term receivables, combined.

Since publicly traded Sangoma Technologies shares are worth a total of CA$169.1m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Sangoma Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

Also relevant is that Sangoma Technologies has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. 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 Sangoma Technologies can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sangoma Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Sangoma Technologies actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although Sangoma Technologies's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CA$11.7m. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in CA$12m. So is Sangoma Technologies's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Sangoma Technologies .

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.