Walsin Lihwa (TPE:1605) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Walsin Lihwa Corporation (TPE:1605) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Walsin Lihwa

What Is Walsin Lihwa's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Walsin Lihwa had NT$43.4b of debt, an increase on NT$36.5b, over one year. However, it also had NT$12.2b in cash, and so its net debt is NT$31.2b.

How Healthy Is Walsin Lihwa's Balance Sheet?

We can see from the most recent balance sheet that Walsin Lihwa had liabilities of NT$27.7b falling due within a year, and liabilities of NT$34.3b due beyond that. Offsetting this, it had NT$12.2b in cash and NT$15.9b in receivables that were due within 12 months. So its liabilities total NT$33.8b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Walsin Lihwa has a market capitalization of NT$58.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Walsin Lihwa's net debt is 3.2 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 48.5 is very high, suggesting that the interest expense on the debt is currently quite low. Notably, Walsin Lihwa's EBIT launched higher than Elon Musk, gaining a whopping 174% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Walsin Lihwa'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Walsin Lihwa reported free cash flow worth 8.6% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Both Walsin Lihwa's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the factors mentioned above, we do feel a bit cautious about Walsin Lihwa's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Be aware that Walsin Lihwa is showing 4 warning signs in our investment analysis , you should know about...

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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