Radiant Opto-Electronics (TPE:6176) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Radiant Opto-Electronics Corporation (TPE:6176) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Radiant Opto-Electronics

What Is Radiant Opto-Electronics's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Radiant Opto-Electronics had debt of NT$9.72b, up from NT$8.89b in one year. However, its balance sheet shows it holds NT$21.7b in cash, so it actually has NT$12.0b net cash.

A Look At Radiant Opto-Electronics' Liabilities

We can see from the most recent balance sheet that Radiant Opto-Electronics had liabilities of NT$25.7b falling due within a year, and liabilities of NT$806.1m due beyond that. Offsetting this, it had NT$21.7b in cash and NT$14.9b in receivables that were due within 12 months. So it actually has NT$10.2b more liquid assets than total liabilities.

It's good to see that Radiant Opto-Electronics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Radiant Opto-Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Radiant Opto-Electronics has increased its EBIT by 9.8% over twelve months, which should ease any concerns about debt repayment. 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 Radiant Opto-Electronics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Radiant Opto-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, Radiant Opto-Electronics recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Radiant Opto-Electronics has net cash of NT$12.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in NT$4.6b. So is Radiant Opto-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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Radiant Opto-Electronics you should know about.

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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