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. As with many other companies Sun Race Sturmey-Archer Inc. (TPE:1526) makes use of 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 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 Sun Race Sturmey-Archer
What Is Sun Race Sturmey-Archer's Net Debt?
As you can see below, Sun Race Sturmey-Archer had NT$147.4m of debt at September 2020, down from NT$335.0m a year prior. But on the other hand it also has NT$355.4m in cash, leading to a NT$208.0m net cash position.
How Strong Is Sun Race Sturmey-Archer's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sun Race Sturmey-Archer had liabilities of NT$530.6m due within 12 months and liabilities of NT$72.0m due beyond that. Offsetting this, it had NT$355.4m in cash and NT$181.0m in receivables that were due within 12 months. So its liabilities total NT$66.2m more than the combination of its cash and short-term receivables.
Given Sun Race Sturmey-Archer has a market capitalization of NT$2.40b, it's hard to believe these liabilities pose much threat. 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, Sun Race Sturmey-Archer also has more cash than debt, so we're pretty confident it can manage its debt safely.
Another good sign is that Sun Race Sturmey-Archer has been able to increase its EBIT by 20% 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 Sun Race Sturmey-Archer's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sun Race Sturmey-Archer 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. Over the last three years, Sun Race Sturmey-Archer actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
We could understand if investors are concerned about Sun Race Sturmey-Archer's liabilities, but we can be reassured by the fact it has has net cash of NT$208.0m. The cherry on top was that in converted 149% of that EBIT to free cash flow, bringing in NT$301m. So is Sun Race Sturmey-Archer's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with Sun Race Sturmey-Archer , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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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About TWSE:1526
Low with imperfect balance sheet.
