Here's Why SemiLEDs (NASDAQ:LEDS) Can Afford Some 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.' 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 note that SemiLEDs Corporation (NASDAQ:LEDS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SemiLEDs

What Is SemiLEDs's Debt?

As you can see below, SemiLEDs had US$3.72m of debt at August 2024, down from US$6.37m a year prior. However, because it has a cash reserve of US$1.67m, its net debt is less, at about US$2.05m.

How Strong Is SemiLEDs' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SemiLEDs had liabilities of US$7.02m due within 12 months and liabilities of US$1.87m due beyond that. On the other hand, it had cash of US$1.67m and US$416.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.80m.

This deficit is considerable relative to its market capitalization of US$9.30m, so it does suggest shareholders should keep an eye on SemiLEDs' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is SemiLEDs's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, SemiLEDs made a loss at the EBIT level, and saw its revenue drop to US$5.2m, which is a fall of 13%. We would much prefer see growth.

Caveat Emptor

Not only did SemiLEDs's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable US$3.0m at the EBIT level. 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through US$517k of cash over the last year. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SemiLEDs is showing 4 warning signs in our investment analysis , and 2 of those are potentially serious...

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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