We Think Zyxel Group (TWSE:3704) 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 note that Zyxel Group Corporation (TWSE:3704) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Zyxel Group

What Is Zyxel Group's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Zyxel Group had debt of NT$3.77b, up from NT$2.74b in one year. However, its balance sheet shows it holds NT$6.68b in cash, so it actually has NT$2.92b net cash.

How Strong Is Zyxel Group's Balance Sheet?

The latest balance sheet data shows that Zyxel Group had liabilities of NT$9.93b due within a year, and liabilities of NT$2.60b falling due after that. Offsetting these obligations, it had cash of NT$6.68b as well as receivables valued at NT$5.99b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Zyxel Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$16.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Zyxel Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Zyxel Group if management cannot prevent a repeat of the 77% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zyxel Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zyxel Group 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 most recent three years, Zyxel Group recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zyxel Group has net cash of NT$2.92b, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in NT$842m. So we are not troubled with Zyxel Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Zyxel Group , and understanding them should be part of your investment process.

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. 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.