Would Leader Electronics (TPE:3058) Be Better Off With Less Debt?

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.' 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. We note that Leader Electronics Inc. (TPE:3058) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Leader Electronics

How Much Debt Does Leader Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Leader Electronics had debt of NT$1.50b, up from NT$1.30b in one year. However, because it has a cash reserve of NT$848.7m, its net debt is less, at about NT$656.0m.

A Look At Leader Electronics' Liabilities

According to the last reported balance sheet, Leader Electronics had liabilities of NT$2.56b due within 12 months, and liabilities of NT$423.7m due beyond 12 months. Offsetting this, it had NT$848.7m in cash and NT$1.27b in receivables that were due within 12 months. So its liabilities total NT$871.4m more than the combination of its cash and short-term receivables.

Leader Electronics has a market capitalization of NT$2.11b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Leader Electronics will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Leader Electronics had a loss before interest and tax, and actually shrunk its revenue by 11%, to NT$4.2b. We would much prefer see growth.

Caveat Emptor

Not only did Leader Electronics's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$78m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled NT$42m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Leader Electronics (including 1 which can't be ignored) .

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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