Trio Industrial Electronics Group (HKG:1710) Seems To Use Debt Rather Sparingly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Trio Industrial Electronics Group Limited (HKG:1710) makes use of debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Trio Industrial Electronics Group

What Is Trio Industrial Electronics Group's Net Debt?

The image below, which you can click on for greater detail, shows that Trio Industrial Electronics Group had debt of HK$23.0m at the end of December 2020, a reduction from HK$37.1m over a year. But it also has HK$99.2m in cash to offset that, meaning it has HK$76.3m net cash.

How Strong Is Trio Industrial Electronics Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Trio Industrial Electronics Group had liabilities of HK$158.9m due within 12 months and liabilities of HK$20.1m due beyond that. On the other hand, it had cash of HK$99.2m and HK$183.0m worth of receivables due within a year. So it actually has HK$103.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Trio Industrial Electronics Group's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Trio Industrial Electronics Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Trio Industrial Electronics Group has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Trio Industrial Electronics Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Trio Industrial Electronics Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Trio Industrial Electronics Group's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Trio Industrial Electronics Group has net cash of HK$76.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 26% year-on-year EBIT growth. So is Trio Industrial Electronics Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Trio Industrial Electronics Group has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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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