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 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. As with many other companies Cutera, Inc. (NASDAQ:CUTR) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.
What Is Cutera’s Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Cutera had debt of US$134.0m, up from US$7.17m in one year. But on the other hand it also has US$162.5m in cash, leading to a US$28.5m net cash position.
How Healthy Is Cutera’s Balance Sheet?
We can see from the most recent balance sheet that Cutera had liabilities of US$63.1m falling due within a year, and liabilities of US$150.0m due beyond that. Offsetting these obligations, it had cash of US$162.5m as well as receivables valued at US$31.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$19.5m.
Given Cutera has a market capitalization of US$664.0m, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Cutera also has more cash than debt, so we’re pretty confident it can manage its debt safely.
We also note that Cutera improved its EBIT from a last year’s loss to a positive US$6.1m. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Cutera’s ability to maintain a healthy balance sheet going forward.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Cutera 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. Looking at the most recent year, Cutera recorded free cash flow of 35% of its EBIT, which is weaker than we’d expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Cutera’s liabilities, but we can be reassured by the fact it has has net cash of US$28.5m. So we are not troubled with Cutera’s debt use. The balance sheet is clearly the area to focus on when you are analysing debt.
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