Does Sunonwealth Electric Machine Industry (TPE:2421) Have A Healthy Balance Sheet?

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.' 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. Importantly, Sunonwealth Electric Machine Industry Co., Ltd. (TPE:2421) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Sunonwealth Electric Machine Industry

How Much Debt Does Sunonwealth Electric Machine Industry Carry?

As you can see below, at the end of September 2020, Sunonwealth Electric Machine Industry had NT$1.30b of debt, up from NT$959.1m a year ago. Click the image for more detail. However, it does have NT$1.82b in cash offsetting this, leading to net cash of NT$515.9m.

How Strong Is Sunonwealth Electric Machine Industry's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunonwealth Electric Machine Industry had liabilities of NT$4.82b due within 12 months and liabilities of NT$880.4m due beyond that. Offsetting these obligations, it had cash of NT$1.82b as well as receivables valued at NT$3.51b due within 12 months. So it has liabilities totalling NT$371.4m more than its cash and near-term receivables, combined.

Of course, Sunonwealth Electric Machine Industry has a market capitalization of NT$14.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Sunonwealth Electric Machine Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Sunonwealth Electric Machine Industry has boosted its EBIT by 81%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Sunonwealth Electric Machine Industry's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sunonwealth Electric Machine 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 last three years, Sunonwealth Electric Machine Industry recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Sunonwealth Electric Machine Industry's liabilities, but we can be reassured by the fact it has has net cash of NT$515.9m. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in NT$1.1b. So we don't think Sunonwealth Electric Machine 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. Case in point: We've spotted 1 warning sign for Sunonwealth Electric Machine Industry you should be aware of.

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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