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.' 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. Importantly, CSP Inc. (NASDAQ:CSPI) does carry debt. But the more important question is: how much risk is that debt creating?
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. 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 think about a company's use of debt, we first look at cash and debt together.
What Is CSP's Debt?
The image below, which you can click on for greater detail, shows that at June 2020 CSP had debt of US$5.71m, up from none in one year. However, its balance sheet shows it holds US$20.0m in cash, so it actually has US$14.3m net cash.
How Strong Is CSP's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that CSP had liabilities of US$14.1m due within 12 months and liabilities of US$11.7m due beyond that. Offsetting this, it had US$20.0m in cash and US$13.5m in receivables that were due within 12 months. So it actually has US$7.70m more liquid assets than total liabilities.
This excess liquidity suggests that CSP is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, CSP boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is CSP'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, CSP made a loss at the EBIT level, and saw its revenue drop to US$68m, which is a fall of 11%. That's not what we would hope to see.
So How Risky Is CSP?
Although CSP had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$1.9m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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 CSP is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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