Is Lemtech Holdings (TPE:4912) Using Too Much 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.' 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 Lemtech Holdings Co., Limited (TPE:4912) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Lemtech Holdings

What Is Lemtech Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Lemtech Holdings had NT$1.12b of debt in December 2020, down from NT$1.90b, one year before. But on the other hand it also has NT$1.65b in cash, leading to a NT$529.8m net cash position.

How Strong Is Lemtech Holdings' Balance Sheet?

We can see from the most recent balance sheet that Lemtech Holdings had liabilities of NT$3.02b falling due within a year, and liabilities of NT$781.2m due beyond that. Offsetting this, it had NT$1.65b in cash and NT$2.23b in receivables that were due within 12 months. So it actually has NT$79.3m more liquid assets than total liabilities.

Having regard to Lemtech Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$9.53b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Lemtech Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Lemtech Holdings has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. 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 Lemtech Holdings 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 Lemtech Holdings 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 most recent three years, Lemtech Holdings recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Lemtech Holdings has net cash of NT$529.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 74% over the last year. So we don't think Lemtech Holdings's use of debt is risky. 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. We've identified 4 warning signs with Lemtech Holdings , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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. 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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