Is SemiLEDs (NASDAQ:LEDS) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies SemiLEDs Corporation (NASDAQ:LEDS) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for SemiLEDs

How Much Debt Does SemiLEDs Carry?

You can click the graphic below for the historical numbers, but it shows that SemiLEDs had US$6.57m of debt in May 2023, down from US$7.18m, one year before. However, because it has a cash reserve of US$3.04m, its net debt is less, at about US$3.52m.

How Healthy Is SemiLEDs' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SemiLEDs had liabilities of US$9.75m due within 12 months and liabilities of US$2.81m due beyond that. Offsetting these obligations, it had cash of US$3.04m as well as receivables valued at US$981.0k due within 12 months. So its liabilities total US$8.53m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$11.3m, so it does suggest shareholders should keep an eye on SemiLEDs' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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$6.2m, which is a fall of 9.5%. We would much prefer see growth.

Caveat Emptor

Importantly, SemiLEDs had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable US$3.4m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$731k in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. Be aware that SemiLEDs is showing 3 warning signs in our investment analysis , and 1 of those is concerning...

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.