Lite-On Technology (TPE:2301) Could Easily Take On More Debt

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, Lite-On Technology Corporation (TPE:2301) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Lite-On Technology

What Is Lite-On Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Lite-On Technology had debt of NT$26.4b at the end of September 2020, a reduction from NT$30.9b over a year. However, its balance sheet shows it holds NT$68.6b in cash, so it actually has NT$42.2b net cash.

How Healthy Is Lite-On Technology's Balance Sheet?

According to the last reported balance sheet, Lite-On Technology had liabilities of NT$100.4b due within 12 months, and liabilities of NT$2.53b due beyond 12 months. On the other hand, it had cash of NT$68.6b and NT$42.0b worth of receivables due within a year. So it can boast NT$7.76b more liquid assets than total liabilities.

This short term liquidity is a sign that Lite-On Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Lite-On Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Lite-On Technology grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 Lite-On Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lite-On Technology 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, Lite-On Technology actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Lite-On Technology has net cash of NT$42.2b, as well as more liquid assets than liabilities. The cherry on top was that in converted 122% of that EBIT to free cash flow, bringing in NT$15b. So is Lite-On Technology'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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Lite-On Technology 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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