Is Edison Opto (TPE:3591) Using Debt In A Risky Way?

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. Importantly, Edison Opto Corporation (TPE:3591) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Edison Opto

What Is Edison Opto's Debt?

As you can see below, at the end of September 2020, Edison Opto had NT$423.7m of debt, up from NT$240.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$1.22b in cash, so it actually has NT$793.3m net cash.

A Look At Edison Opto's Liabilities

Zooming in on the latest balance sheet data, we can see that Edison Opto had liabilities of NT$877.6m due within 12 months and liabilities of NT$89.8m due beyond that. On the other hand, it had cash of NT$1.22b and NT$420.4m worth of receivables due within a year. So it can boast NT$669.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Edison Opto's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Edison Opto boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Edison Opto's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Edison Opto made a loss at the EBIT level, and saw its revenue drop to NT$1.9b, which is a fall of 16%. We would much prefer see growth.

So How Risky Is Edison Opto?

While Edison Opto lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow NT$133m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. For example Edison Opto has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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