Is Patec Precision Industry (TWSE:2236) A Risky Investment?

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.' 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. We note that Patec Precision Industry Co., Ltd. (TWSE:2236) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View 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 at September 2023 Patec Precision Industry had debt of NT$472.1m, up from NT$331.3m in one year. However, it does have NT$654.4m in cash offsetting this, leading to net cash of NT$182.3m.

A Look At Patec Precision Industry's Liabilities

According to the last reported balance sheet, Patec Precision Industry had liabilities of NT$616.5m due within 12 months, and liabilities of NT$515.2m due beyond 12 months. Offsetting these obligations, it had cash of NT$654.4m as well as receivables valued at NT$561.1m due within 12 months. So it can boast NT$83.7m more liquid assets than total liabilities.

This surplus suggests that Patec Precision Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Patec Precision Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Patec Precision Industry grew its EBIT by 112% 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 you can't view debt in total isolation; since Patec Precision Industry will need earnings to service that debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. While Patec Precision Industry has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Patec Precision Industry recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Patec Precision Industry has NT$182.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 112% over the last year. So we don't think Patec Precision Industry's use of debt is 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. To that end, you should learn about the 2 warning signs we've spotted with Patec Precision Industry (including 1 which can't be ignored) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.