Is Ability Enterprise (TPE:2374) Using Debt Sensibly?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Ability Enterprise Co., Ltd. (TPE:2374) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for Ability Enterprise

How Much Debt Does Ability Enterprise Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Ability Enterprise had debt of NT$1.41b, up from NT$860.0m in one year. But it also has NT$3.16b in cash to offset that, meaning it has NT$1.76b net cash.

How Healthy Is Ability Enterprise's Balance Sheet?

The latest balance sheet data shows that Ability Enterprise had liabilities of NT$3.26b due within a year, and liabilities of NT$106.1m falling due after that. On the other hand, it had cash of NT$3.16b and NT$664.0m worth of receivables due within a year. So it actually has NT$461.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Ability Enterprise could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Ability Enterprise boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ability Enterprise 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.

In the last year Ability Enterprise had a loss before interest and tax, and actually shrunk its revenue by 49%, to NT$3.7b. That makes us nervous, to say the least.

So How Risky Is Ability Enterprise?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Ability Enterprise had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of NT$337m and booked a NT$619m accounting loss. Given it only has net cash of NT$1.76b, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Be aware that Ability Enterprise is showing 1 warning sign in our investment analysis , 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.

If you decide to trade Ability Enterprise, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.