Would Lealea Enterprise (TPE:1444) Be Better Off With Less Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Lealea Enterprise Co., Ltd. (TPE:1444) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Lealea Enterprise

What Is Lealea Enterprise's Net Debt?

The image below, which you can click on for greater detail, shows that Lealea Enterprise had debt of NT$3.73b at the end of September 2020, a reduction from NT$5.97b over a year. However, it also had NT$1.68b in cash, and so its net debt is NT$2.05b.

A Look At Lealea Enterprise's Liabilities

The latest balance sheet data shows that Lealea Enterprise had liabilities of NT$4.36b due within a year, and liabilities of NT$1.13b falling due after that. Offsetting these obligations, it had cash of NT$1.68b as well as receivables valued at NT$683.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.12b.

While this might seem like a lot, it is not so bad since Lealea Enterprise has a market capitalization of NT$11.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lealea Enterprise'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.

Over 12 months, Lealea Enterprise made a loss at the EBIT level, and saw its revenue drop to NT$8.8b, which is a fall of 31%. That makes us nervous, to say the least.

Caveat Emptor

While Lealea Enterprise's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$345m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of NT$714m into a profit. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Lealea Enterprise is showing 1 warning sign in our investment analysis , you should know about...

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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