We Think Chicony Power Technology (TPE:6412) Can Manage Its Debt With Ease

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.' 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. We note that Chicony Power Technology Co., Ltd. (TPE:6412) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chicony Power Technology

What Is Chicony Power Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Chicony Power Technology had NT$567.2m of debt in September 2020, down from NT$2.21b, one year before. However, its balance sheet shows it holds NT$1.89b in cash, so it actually has NT$1.32b net cash.

How Strong Is Chicony Power Technology's Balance Sheet?

The latest balance sheet data shows that Chicony Power Technology had liabilities of NT$14.6b due within a year, and liabilities of NT$277.1m falling due after that. Offsetting this, it had NT$1.89b in cash and NT$9.86b in receivables that were due within 12 months. So it has liabilities totalling NT$3.10b more than its cash and near-term receivables, combined.

Since publicly traded Chicony Power Technology shares are worth a total of NT$27.7b, it seems unlikely that this level of liabilities would be a major threat. 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, Chicony Power Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Chicony Power Technology has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. 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 Chicony Power Technology'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Chicony Power Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Chicony Power Technology produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Chicony Power Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$1.32b. And we liked the look of last year's 25% year-on-year EBIT growth. So is Chicony Power Technology's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Chicony Power 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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