Health Check: How Prudently Does Phihong Technology (TPE:2457) Use Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Phihong Technology Co., Ltd. (TPE:2457) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Phihong Technology

What Is Phihong Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Phihong Technology had NT$1.43b of debt, an increase on NT$1.14b, over one year. However, it does have NT$2.58b in cash offsetting this, leading to net cash of NT$1.15b.

How Healthy Is Phihong Technology's Balance Sheet?

According to the last reported balance sheet, Phihong Technology had liabilities of NT$4.42b due within 12 months, and liabilities of NT$518.8m due beyond 12 months. Offsetting this, it had NT$2.58b in cash and NT$1.99b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$369.0m.

Of course, Phihong Technology has a market capitalization of NT$5.34b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Phihong Technology also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Phihong Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Phihong Technology made a loss at the EBIT level, and saw its revenue drop to NT$9.1b, which is a fall of 18%. We would much prefer see growth.

So How Risky Is Phihong Technology?

Although Phihong Technology had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of NT$94m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Phihong Technology has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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