We Think Makalot Industrial (TPE:1477) 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.' 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. We can see that Makalot Industrial Co., Ltd. (TPE:1477) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Makalot Industrial

What Is Makalot Industrial's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Makalot Industrial had debt of NT$2.09b, up from NT$940.8m in one year. However, its balance sheet shows it holds NT$3.84b in cash, so it actually has NT$1.75b net cash.

How Healthy Is Makalot Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Makalot Industrial had liabilities of NT$6.92b due within 12 months and liabilities of NT$386.3m due beyond that. Offsetting these obligations, it had cash of NT$3.84b as well as receivables valued at NT$3.59b due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Makalot Industrial's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$40.9b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Makalot Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Makalot Industrial grew its EBIT at 10% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Makalot Industrial can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Makalot Industrial 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, Makalot Industrial produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Makalot Industrial has net cash of NT$1.75b, as well as more liquid assets than liabilities. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in NT$2.4b. So we don't think Makalot Industrial'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 Makalot Industrial 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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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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