We Think Hanpin Electron (TPE:2488) Can Stay On Top Of Its Debt

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.' 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, Hanpin Electron Co., Ltd. (TPE:2488) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hanpin Electron

What Is Hanpin Electron's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Hanpin Electron had debt of NT$379.8m, up from NT$292.0m in one year. However, it does have NT$1.80b in cash offsetting this, leading to net cash of NT$1.42b.

How Strong Is Hanpin Electron's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hanpin Electron had liabilities of NT$973.0m due within 12 months and liabilities of NT$288.8m due beyond that. Offsetting this, it had NT$1.80b in cash and NT$361.0m in receivables that were due within 12 months. So it can boast NT$902.1m more liquid assets than total liabilities.

This surplus strongly suggests that Hanpin Electron has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Hanpin Electron boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Hanpin Electron if management cannot prevent a repeat of the 37% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hanpin Electron 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Hanpin Electron 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 three years, Hanpin Electron generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Hanpin Electron has NT$1.42b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in NT$322m. So is Hanpin Electron'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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Hanpin Electron (including 1 which is potentially serious) .

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.

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