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.' 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. We note that Orion Energy Systems, Inc. (NASDAQ:OESX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Orion Energy Systems's Debt?
As you can see below, at the end of September 2020, Orion Energy Systems had US$7.93m of debt, up from US$3.76m a year ago. Click the image for more detail. However, it does have US$12.1m in cash offsetting this, leading to net cash of US$4.20m.
A Look At Orion Energy Systems' Liabilities
We can see from the most recent balance sheet that Orion Energy Systems had liabilities of US$23.8m falling due within a year, and liabilities of US$12.6m due beyond that. Offsetting this, it had US$12.1m in cash and US$20.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.07m.
This state of affairs indicates that Orion Energy Systems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$336.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Orion Energy Systems 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 Orion Energy Systems if management cannot prevent a repeat of the 77% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Orion Energy Systems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Orion Energy Systems 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. In the last two years, Orion Energy Systems created free cash flow amounting to 5.1% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Orion Energy Systems has US$4.20m in net cash. So while Orion Energy Systems does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Orion Energy Systems .
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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Orion Energy Systems
Orion Energy Systems, Inc. researches, designs, develops, manufactures, markets, sells, installs, and implements energy management systems for commercial office and retail, exterior area lighting, and industrial applications in North America.
High growth potential with adequate balance sheet.