Is ABOV Semiconductor (KOSDAQ:102120) A Risky Investment?

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. We note that ABOV Semiconductor Co., Ltd. (KOSDAQ:102120) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for ABOV Semiconductor

What Is ABOV Semiconductor's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 ABOV Semiconductor had debt of ₩23.5b, up from none in one year. But on the other hand it also has ₩67.6b in cash, leading to a ₩44.1b net cash position.

A Look At ABOV Semiconductor's Liabilities

According to the last reported balance sheet, ABOV Semiconductor had liabilities of ₩34.8b due within 12 months, and liabilities of ₩7.04b due beyond 12 months. Offsetting this, it had ₩67.6b in cash and ₩19.0b in receivables that were due within 12 months. So it actually has ₩44.8b more liquid assets than total liabilities.

This surplus suggests that ABOV Semiconductor is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that ABOV Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, ABOV Semiconductor grew its EBIT by 156% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ABOV Semiconductor's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ABOV Semiconductor 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. During the last three years, ABOV Semiconductor generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case ABOV Semiconductor has ₩44.1b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in ₩17b. The bottom line is that we do not find ABOV Semiconductor's debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with ABOV Semiconductor .

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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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