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. 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. As with many other companies Orion Energy Systems, Inc. (NASDAQ:OESX) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is Orion Energy Systems's Net Debt?
As you can see below, at the end of September 2019, Orion Energy Systems had US$3.76m of debt, up from US$1.4 a year ago. Click the image for more detail. But on the other hand it also has US$11.1m in cash, leading to a US$7.34m net cash position.
A Look At Orion Energy Systems's Liabilities
We can see from the most recent balance sheet that Orion Energy Systems had liabilities of US$40.9m falling due within a year, and liabilities of US$5.26m due beyond that. Offsetting these obligations, it had cash of US$11.1m as well as receivables valued at US$31.2m due within 12 months. So its liabilities total US$3.82m more than the combination of its cash and short-term receivables.
Of course, Orion Energy Systems has a market capitalization of US$95.5m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Orion Energy Systems boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Orion Energy Systems turned things around in the last 12 months, delivering and EBIT of US$9.8m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Orion Energy Systems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Orion Energy Systems 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. In the last year, Orion Energy Systems's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
We could understand if investors are concerned about Orion Energy Systems's liabilities, but we can be reassured by the fact it has has net cash of US$7.34m. So we don't have any problem with Orion Energy Systems's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Orion Energy Systems insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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