These 4 Measures Indicate That Young Fast Optoelectronics (TPE:3622) Is Using Debt Safely

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Young Fast Optoelectronics Co., Ltd. (TPE:3622) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Young Fast Optoelectronics

What Is Young Fast Optoelectronics's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Young Fast Optoelectronics had NT$65.7m of debt, an increase on NT$60.0m, over one year. However, its balance sheet shows it holds NT$2.90b in cash, so it actually has NT$2.83b net cash.

How Strong Is Young Fast Optoelectronics' Balance Sheet?

We can see from the most recent balance sheet that Young Fast Optoelectronics had liabilities of NT$377.9m falling due within a year, and liabilities of NT$63.6m due beyond that. Offsetting these obligations, it had cash of NT$2.90b as well as receivables valued at NT$250.4m due within 12 months. So it actually has NT$2.71b more liquid assets than total liabilities.

This excess liquidity is a great indication that Young Fast Optoelectronics' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Young Fast Optoelectronics has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Young Fast Optoelectronics turned things around in the last 12 months, delivering and EBIT of NT$19m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Young Fast Optoelectronics will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Young Fast Optoelectronics 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, Young Fast Optoelectronics 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 Young Fast Optoelectronics has net cash of NT$2.83b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$48m, being 251% of its EBIT. So we don't think Young Fast Optoelectronics's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Young Fast Optoelectronics .

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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