The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 DZS Inc. (NASDAQ:DZSI) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does DZS Carry?
As you can see below, at the end of June 2022, DZS had US$24.7m of debt, up from none a year ago. Click the image for more detail. However, it does have US$17.1m in cash offsetting this, leading to net debt of about US$7.54m.
How Strong Is DZS' Balance Sheet?
We can see from the most recent balance sheet that DZS had liabilities of US$125.0m falling due within a year, and liabilities of US$62.8m due beyond that. Offsetting this, it had US$17.1m in cash and US$119.6m in receivables that were due within 12 months. So it has liabilities totalling US$51.0m more than its cash and near-term receivables, combined.
Given DZS has a market capitalization of US$317.2m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine DZS'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.
Over 12 months, DZS reported revenue of US$355m, which is a gain of 2.4%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Caveat Emptor
Importantly, DZS had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$11m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$42m of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for DZS that you should be aware of.
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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