Is Bright LED Electronics (TPE:3031) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Bright LED Electronics Corp. (TPE:3031) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Bright LED Electronics

What Is Bright LED Electronics's Net Debt?

The image below, which you can click on for greater detail, shows that Bright LED Electronics had debt of NT$60.0m at the end of September 2020, a reduction from NT$64.5m over a year. However, its balance sheet shows it holds NT$818.0m in cash, so it actually has NT$758.0m net cash.

How Strong Is Bright LED Electronics' Balance Sheet?

According to the last reported balance sheet, Bright LED Electronics had liabilities of NT$482.3m due within 12 months, and liabilities of NT$57.6m due beyond 12 months. On the other hand, it had cash of NT$818.0m and NT$721.2m worth of receivables due within a year. So it can boast NT$999.4m more liquid assets than total liabilities.

This surplus strongly suggests that Bright LED Electronics has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Bright LED Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Bright LED Electronics's load is not too heavy, because its EBIT was down 35% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Bright LED Electronics's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Bright LED Electronics 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, Bright LED Electronics actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Bright LED Electronics has net cash of NT$758.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$326m, being 309% of its EBIT. So is Bright LED Electronics's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Bright LED Electronics you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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