Is Lumentum Holdings (NASDAQ:LITE) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Lumentum Holdings Inc. (NASDAQ:LITE) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Lumentum Holdings

What Is Lumentum Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Lumentum Holdings had US$2.82b of debt, an increase on US$2.32b, over one year. However, because it has a cash reserve of US$1.22b, its net debt is less, at about US$1.60b.

How Strong Is Lumentum Holdings' Balance Sheet?

The latest balance sheet data shows that Lumentum Holdings had liabilities of US$658.4m due within a year, and liabilities of US$2.72b falling due after that. Offsetting these obligations, it had cash of US$1.22b as well as receivables valued at US$255.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.90b.

While this might seem like a lot, it is not so bad since Lumentum Holdings has a market capitalization of US$3.40b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lumentum Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Lumentum Holdings made a loss at the EBIT level, and saw its revenue drop to US$1.4b, which is a fall of 21%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Lumentum Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$215m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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 US$97m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. To that end, you should learn about the 2 warning signs we've spotted with Lumentum Holdings (including 1 which doesn't sit too well with us) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.