uCloudlink Group (NASDAQ:UCL) Could Easily Take On More 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 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. Importantly, uCloudlink Group Inc. (NASDAQ:UCL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for uCloudlink Group

What Is uCloudlink Group's Net Debt?

As you can see below, uCloudlink Group had US$3.11m of debt at March 2023, down from US$10.3m a year prior. However, it does have US$29.3m in cash offsetting this, leading to net cash of US$26.2m.

How Strong Is uCloudlink Group's Balance Sheet?

The latest balance sheet data shows that uCloudlink Group had liabilities of US$36.5m due within a year, and liabilities of US$240.0k falling due after that. Offsetting these obligations, it had cash of US$29.3m as well as receivables valued at US$8.36m due within 12 months. So it actually has US$993.0k more liquid assets than total liabilities.

Having regard to uCloudlink Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$105.8m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that uCloudlink Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Although uCloudlink Group made a loss at the EBIT level, last year, it was also good to see that it generated US$5.7m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if uCloudlink Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While uCloudlink Group 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. Over the last year, uCloudlink Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that uCloudlink Group has net cash of US$26.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 170% of that EBIT to free cash flow, bringing in US$9.7m. So is uCloudlink Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with uCloudlink Group (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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.