Is Merry Electronics (TWSE:2439) A Risky Investment?

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. We can see that Merry Electronics Co., Ltd. (TWSE:2439) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Merry Electronics

What Is Merry Electronics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Merry Electronics had NT$5.56b of debt in December 2023, down from NT$6.46b, one year before. But on the other hand it also has NT$6.69b in cash, leading to a NT$1.12b net cash position.

How Healthy Is Merry Electronics' Balance Sheet?

We can see from the most recent balance sheet that Merry Electronics had liabilities of NT$15.9b falling due within a year, and liabilities of NT$3.28b due beyond that. Offsetting these obligations, it had cash of NT$6.69b as well as receivables valued at NT$9.72b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.72b.

Since publicly traded Merry Electronics shares are worth a total of NT$25.2b, 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, Merry Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Merry Electronics has increased its EBIT by 6.0% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Merry Electronics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Merry Electronics 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. Happily for any shareholders, Merry Electronics actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Merry Electronics'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$1.12b. The cherry on top was that in converted 214% of that EBIT to free cash flow, bringing in NT$1.7b. So we don't think Merry Electronics's use of debt is risky. 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. We've identified 1 warning sign with Merry Electronics , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.