We Think Radiant Opto-Electronics (TWSE:6176) Can Stay On Top Of Its 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. We can see that Radiant Opto-Electronics Corporation (TWSE:6176) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Radiant Opto-Electronics

How Much Debt Does Radiant Opto-Electronics Carry?

You can click the graphic below for the historical numbers, but it shows that Radiant Opto-Electronics had NT$3.40b of debt in March 2024, down from NT$10.6b, one year before. However, its balance sheet shows it holds NT$38.9b in cash, so it actually has NT$35.5b net cash.

How Strong Is Radiant Opto-Electronics' Balance Sheet?

We can see from the most recent balance sheet that Radiant Opto-Electronics had liabilities of NT$19.9b falling due within a year, and liabilities of NT$3.62b due beyond that. Offsetting these obligations, it had cash of NT$38.9b as well as receivables valued at NT$11.0b due within 12 months. So it can boast NT$26.4b more liquid assets than total liabilities.

This luscious liquidity implies that Radiant Opto-Electronics' balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Radiant Opto-Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Radiant Opto-Electronics has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Radiant Opto-Electronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Radiant Opto-Electronics actually produced more free cash flow than EBIT over the last three years. 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 Radiant Opto-Electronics has net cash of NT$35.5b, as well as more liquid assets than liabilities. The cherry on top was that in converted 120% of that EBIT to free cash flow, bringing in NT$6.7b. 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 2 warning signs for Radiant Opto-Electronics (of which 1 shouldn't be ignored!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com