Here's Why Meiloon Industrial (TPE:2477) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Meiloon Industrial Co., Ltd. (TPE:2477) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Meiloon Industrial

How Much Debt Does Meiloon Industrial Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Meiloon Industrial had debt of NT$1.77b, up from NT$702.0m in one year. However, it does have NT$1.80b in cash offsetting this, leading to net cash of NT$32.3m.

How Strong Is Meiloon Industrial's Balance Sheet?

According to the last reported balance sheet, Meiloon Industrial had liabilities of NT$1.58b due within 12 months, and liabilities of NT$1.78b due beyond 12 months. Offsetting this, it had NT$1.80b in cash and NT$649.4m in receivables that were due within 12 months. So it has liabilities totalling NT$909.6m more than its cash and near-term receivables, combined.

Given Meiloon Industrial has a market capitalization of NT$5.96b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Meiloon Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Meiloon Industrial's load is not too heavy, because its EBIT was down 41% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Meiloon Industrial 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Meiloon 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, Meiloon Industrial produced sturdy free cash flow equating to 52% 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 Meiloon Industrial does have more liabilities than liquid assets, it also has net cash of NT$32.3m. So we don't have any problem with Meiloon Industrial's use of debt. 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. Case in point: We've spotted 3 warning signs for Meiloon Industrial you should be aware of, and 2 of them can't be ignored.

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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