Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, LRAD Corporation (NASDAQ:LRAD) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is LRAD's Debt?
As you can see below, LRAD had US$324.8k of debt at June 2019, down from US$740.4k a year prior. However, it does have US$14.3m in cash offsetting this, leading to net cash of US$13.9m.
How Strong Is LRAD's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that LRAD had liabilities of US$4.74m due within 12 months and liabilities of US$2.55m due beyond that. On the other hand, it had cash of US$14.3m and US$6.81m worth of receivables due within a year. So it can boast US$13.8m more liquid assets than total liabilities.
This surplus suggests that LRAD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that LRAD has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that LRAD's load is not too heavy, because its EBIT was down 66% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine LRAD'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While LRAD 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. Looking at the most recent two years, LRAD recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While we empathize with investors who find debt concerning, you should keep in mind that LRAD has net cash of US$14m, as well as more liquid assets than liabilities. So we are not troubled with LRAD's debt use. We'd be motivated to research the stock further if we found out that LRAD insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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