Is Merida Industry (TPE:9914) Using Too Much 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.' 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 can see that Merida Industry Co., Ltd. (TPE:9914) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Merida Industry

What Is Merida Industry's Debt?

As you can see below, Merida Industry had NT$2.23b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has NT$5.31b in cash to offset that, meaning it has NT$3.08b net cash.

A Look At Merida Industry's Liabilities

According to the last reported balance sheet, Merida Industry had liabilities of NT$7.56b due within 12 months, and liabilities of NT$4.46b due beyond 12 months. Offsetting this, it had NT$5.31b in cash and NT$2.31b in receivables that were due within 12 months. So it has liabilities totalling NT$4.40b more than its cash and near-term receivables, combined.

Given Merida Industry has a market capitalization of NT$84.9b, it's hard to believe these liabilities pose much 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, Merida Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Merida Industry grew its EBIT by 16% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Merida Industry's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Merida Industry 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, Merida Industry produced sturdy free cash flow equating to 76% 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

We could understand if investors are concerned about Merida Industry's liabilities, but we can be reassured by the fact it has has net cash of NT$3.08b. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in NT$1.7b. So is Merida Industry's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Merida Industry's earnings per share history for free.

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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