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.' 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 D-Link Corporation (TPE:2332) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is D-Link's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 D-Link had NT$51.6m of debt, an increase on none, over one year. However, it does have NT$3.80b in cash offsetting this, leading to net cash of NT$3.75b.
How Strong Is D-Link's Balance Sheet?
We can see from the most recent balance sheet that D-Link had liabilities of NT$5.24b falling due within a year, and liabilities of NT$869.8m due beyond that. On the other hand, it had cash of NT$3.80b and NT$3.31b worth of receivables due within a year. So it actually has NT$1.01b more liquid assets than total liabilities.
This short term liquidity is a sign that D-Link could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that D-Link has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, D-Link made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$17m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is D-Link'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. D-Link 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. Over the last year, D-Link actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case D-Link has NT$3.75b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$715m, being 4,126% of its EBIT. So we don't have any problem with D-Link's use of debt. 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 2 warning signs for D-Link 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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D-Link Corporation researches, develops, and sells local area computer network systems, wireless local area computer networks, and spare parts for integrated circuits in Taiwan and internationally.
Excellent balance sheet with questionable track record.
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