We Think AVerMedia Technologies (TPE:2417) 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 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. We note that AVerMedia Technologies, Inc. (TPE:2417) 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 AVerMedia Technologies

What Is AVerMedia Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 AVerMedia Technologies had NT$383.0m of debt, an increase on none, over one year. But it also has NT$2.53b in cash to offset that, meaning it has NT$2.14b net cash.

How Strong Is AVerMedia Technologies' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AVerMedia Technologies had liabilities of NT$2.77b due within 12 months and liabilities of NT$141.9m due beyond that. On the other hand, it had cash of NT$2.53b and NT$1.90b worth of receivables due within a year. So it actually has NT$1.52b more liquid assets than total liabilities.

This surplus suggests that AVerMedia Technologies is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that AVerMedia Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, AVerMedia Technologies grew its EBIT by 20,970% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AVerMedia Technologies 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AVerMedia Technologies 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 two years, AVerMedia Technologies produced sturdy free cash flow equating to 54% 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

While we empathize with investors who find debt concerning, you should keep in mind that AVerMedia Technologies has net cash of NT$2.14b, as well as more liquid assets than liabilities. And we liked the look of last year's 20,970% year-on-year EBIT growth. So we don't think AVerMedia Technologies's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with AVerMedia Technologies .

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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