Here's Why Ledlink Optics (GTSM:5230) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Ledlink Optics, Inc. (GTSM:5230) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ledlink Optics

What Is Ledlink Optics's Debt?

As you can see below, Ledlink Optics had NT$570.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$534.5m in cash leading to net debt of about NT$35.5m.

How Healthy Is Ledlink Optics' Balance Sheet?

We can see from the most recent balance sheet that Ledlink Optics had liabilities of NT$526.5m falling due within a year, and liabilities of NT$377.7m due beyond that. Offsetting this, it had NT$534.5m in cash and NT$253.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$115.9m.

Since publicly traded Ledlink Optics shares are worth a total of NT$1.19b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.15 times EBITDA, it is initially surprising to see that Ledlink Optics's EBIT has low interest coverage of 2.1 times. So while we're not necessarily alarmed we think that its debt is far from trivial. Importantly, Ledlink Optics's EBIT fell a jaw-dropping 74% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is Ledlink Optics'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. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ledlink Optics actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We weren't impressed with Ledlink Optics's interest cover, and its EBIT growth rate made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. Considering this range of data points, we think Ledlink Optics is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 6 warning signs we've spotted with Ledlink Optics (including 2 which are potentially serious) .

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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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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