We Think Sunonwealth Electric Machine Industry (TPE:2421) Can Manage Its Debt With Ease

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 can see that Sunonwealth Electric Machine Industry Co., Ltd. (TPE:2421) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sunonwealth Electric Machine Industry

What Is Sunonwealth Electric Machine Industry's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Sunonwealth Electric Machine Industry had NT$1.30b of debt, an increase on NT$959.1m, over one year. But on the other hand it also has NT$1.82b in cash, leading to a NT$515.9m net cash position.

How Healthy 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 this, it had NT$1.82b in cash and NT$3.51b in receivables that were 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$13.4b, 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. Despite its noteworthy liabilities, Sunonwealth Electric Machine Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

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. When analysing debt levels, the balance sheet is the obvious place to start. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, Sunonwealth Electric Machine Industry generated free cash flow amounting to a very robust 95% 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 look at a company's total liabilities, it is very reassuring that Sunonwealth Electric Machine Industry has NT$515.9m in net cash. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Sunonwealth Electric Machine Industry has 1 warning sign we think you should be aware of.

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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