Does Patec Precision Industry (TPE:2236) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Patec Precision Industry Co., Ltd. (TPE:2236) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Patec Precision Industry

What Is Patec Precision Industry's Debt?

The image below, which you can click on for greater detail, shows that Patec Precision Industry had debt of NT$380.8m at the end of September 2020, a reduction from NT$405.3m over a year. But it also has NT$689.8m in cash to offset that, meaning it has NT$308.9m net cash.

A Look At Patec Precision Industry's Liabilities

We can see from the most recent balance sheet that Patec Precision Industry had liabilities of NT$641.5m falling due within a year, and liabilities of NT$257.6m due beyond that. On the other hand, it had cash of NT$689.8m and NT$475.2m worth of receivables due within a year. So it actually has NT$266.0m more liquid assets than total liabilities.

This surplus liquidity suggests that Patec Precision Industry's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Patec Precision Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Patec Precision Industry's saving grace is its low debt levels, because its EBIT has tanked 89% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Patec Precision Industry's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Patec Precision Industry 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. Happily for any shareholders, Patec Precision Industry actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Patec Precision Industry has NT$308.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in NT$144m. So is Patec Precision Industry's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Patec Precision Industry is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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