Excel Cell Electronic (TPE:2483) Seems To Use Debt Rather Sparingly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Excel Cell Electronic Co., Ltd. (TPE:2483) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Excel Cell Electronic

What Is Excel Cell Electronic's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Excel Cell Electronic had debt of NT$1.03b, up from NT$773.1m in one year. On the flip side, it has NT$954.5m in cash leading to net debt of about NT$78.8m.

A Look At Excel Cell Electronic's Liabilities

The latest balance sheet data shows that Excel Cell Electronic had liabilities of NT$964.4m due within a year, and liabilities of NT$462.2m falling due after that. Offsetting these obligations, it had cash of NT$954.5m as well as receivables valued at NT$394.4m due within 12 months. So its liabilities total NT$77.8m more than the combination of its cash and short-term receivables.

Of course, Excel Cell Electronic has a market capitalization of NT$2.13b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Excel Cell Electronic's net debt is only 0.47 times its EBITDA. And its EBIT covers its interest expense a whopping 12.6 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Excel Cell Electronic grew its EBIT by 112% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Excel Cell Electronic will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Excel Cell Electronic produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Excel Cell Electronic's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Excel Cell Electronic is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Excel Cell Electronic has 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

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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