Is Arima Communications (TWSE:8101) Using Too Much 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Arima Communications Corp. (TWSE:8101) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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.

View our latest analysis for Arima Communications

How Much Debt Does Arima Communications Carry?

As you can see below, at the end of September 2024, Arima Communications had NT$323.7m of debt, up from NT$267.8m a year ago. Click the image for more detail. However, it also had NT$14.9m in cash, and so its net debt is NT$308.7m.

How Strong Is Arima Communications' Balance Sheet?

The latest balance sheet data shows that Arima Communications had liabilities of NT$176.3m due within a year, and liabilities of NT$266.9m falling due after that. Offsetting these obligations, it had cash of NT$14.9m as well as receivables valued at NT$45.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$383.1m.

This is a mountain of leverage relative to its market capitalization of NT$462.4m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Arima Communications will need earnings to service that debt. 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.

Over 12 months, Arima Communications made a loss at the EBIT level, and saw its revenue drop to NT$123m, which is a fall of 46%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Arima Communications's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping NT$172m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled NT$157m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. For instance, we've identified 5 warning signs for Arima Communications (3 are significant) you should be aware of.

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. 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.