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.' 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. 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 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Meiloon Industrial
How Much Debt Does Meiloon Industrial Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Meiloon Industrial had NT$1.77b of debt, an increase on NT$702.0m, over 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?
Zooming in on the latest balance sheet data, we can see that Meiloon Industrial had liabilities of NT$1.58b due within 12 months and liabilities of NT$1.78b due beyond that. Offsetting these obligations, it had cash of NT$1.80b as well as receivables valued at NT$649.4m due within 12 months. So its liabilities total NT$909.6m more than the combination of its cash and short-term receivables.
Since publicly traded Meiloon Industrial shares are worth a total of NT$6.66b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. 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. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Meiloon Industrial'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 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
Although Meiloon Industrial's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it 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. Take risks, for example - Meiloon Industrial has 4 warning signs (and 2 which are a bit concerning) we think you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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:2477
Excellent balance sheet and fair value.
