Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ 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. Importantly, LightPath Technologies, Inc. (NASDAQ:LPTH) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.
What Is LightPath Technologies’s Net Debt?
The chart below, which you can click on for greater detail, shows that LightPath Technologies had US$5.14m in debt in March 2021; about the same as the year before. But on the other hand it also has US$5.94m in cash, leading to a US$797.5k net cash position.
A Look At LightPath Technologies’ Liabilities
Zooming in on the latest balance sheet data, we can see that LightPath Technologies had liabilities of US$7.74m due within 12 months and liabilities of US$4.97m due beyond that. Offsetting this, it had US$5.94m in cash and US$6.48m in receivables that were due within 12 months. So its liabilities total US$300.0k more than the combination of its cash and short-term receivables.
Having regard to LightPath Technologies’ size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the US$71.2m company is struggling for cash, we still think it’s worth monitoring its balance sheet. Despite its noteworthy liabilities, LightPath Technologies boasts net cash, so it’s fair to say it does not have a heavy debt load!
Better yet, LightPath Technologies grew its EBIT by 100% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine LightPath Technologies’s ability to maintain a healthy balance sheet going forward.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While LightPath Technologies 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 most recent two years, LightPath Technologies recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
We could understand if investors are concerned about LightPath Technologies’s liabilities, but we can be reassured by the fact it has has net cash of US$797.5k. And we liked the look of last year’s 100% year-on-year EBIT growth. So we don’t think LightPath Technologies’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet.