David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies AXT, Inc. (NASDAQ:AXTI) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is AXT's Debt?
The image below, which you can click on for greater detail, shows that at September 2019 AXT had debt of US$5.61m, up from US$291.0k in one year. But on the other hand it also has US$34.0m in cash, leading to a US$28.3m net cash position.
How Strong Is AXT's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that AXT had liabilities of US$23.2m due within 12 months and liabilities of US$3.07m due beyond that. On the other hand, it had cash of US$34.0m and US$17.5m worth of receivables due within a year. So it can boast US$25.1m more liquid assets than total liabilities.
This surplus suggests that AXT is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that AXT has more cash than debt is arguably a good indication that it can manage its debt safely.
The modesty of its debt load may become crucial for AXT if management cannot prevent a repeat of the 89% cut to EBIT 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 ultimately the future profitability of the business will decide if AXT can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. While AXT 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. During the last three years, AXT burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While it is always sensible to investigate a company's debt, in this case AXT has US$28.3m in net cash and a decent-looking balance sheet. So we don't have any problem with AXT's use of debt. Even though AXT lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check outhow earnings have been trending over the last few years.
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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