Does DASAN Zhone Solutions (NASDAQ:DZSI) Have A Healthy Balance Sheet?
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. We can see that DASAN Zhone Solutions, Inc. (NASDAQ:DZSI) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.
See our latest analysis for DASAN Zhone Solutions
What Is DASAN Zhone Solutions's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 DASAN Zhone Solutions had debt of US$58.8m, up from US$52.5m in one year. However, it does have US$56.4m in cash offsetting this, leading to net debt of about US$2.41m.
A Look At DASAN Zhone Solutions's Liabilities
The latest balance sheet data shows that DASAN Zhone Solutions had liabilities of US$93.0m due within a year, and liabilities of US$66.4m falling due after that. Offsetting these obligations, it had cash of US$56.4m as well as receivables valued at US$113.6m due within 12 months. So it can boast US$10.6m more liquid assets than total liabilities.
This surplus suggests that DASAN Zhone Solutions has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Carrying virtually no net debt, DASAN Zhone Solutions has a very light debt load indeed.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While DASAN Zhone Solutions's low debt to EBITDA ratio of 0.20 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 2.9 last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. One way DASAN Zhone Solutions could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 13%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine DASAN Zhone Solutions'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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last two years, DASAN Zhone Solutions 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.
Our View
DASAN Zhone Solutions's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better In particular, we are dazzled with its net debt to EBITDA. When we consider all the factors mentioned above, we do feel a bit cautious about DASAN Zhone Solutions's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that DASAN Zhone Solutions insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
