Wowprime (TPE:2727) Has A Pretty Healthy Balance Sheet

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 note that Wowprime Corp. (TPE:2727) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Wowprime

How Much Debt Does Wowprime Carry?

As you can see below, at the end of September 2020, Wowprime had NT$211.5m of debt, up from none a year ago. Click the image for more detail. However, it does have NT$2.61b in cash offsetting this, leading to net cash of NT$2.39b.

A Look At Wowprime's Liabilities

Zooming in on the latest balance sheet data, we can see that Wowprime had liabilities of NT$5.49b due within 12 months and liabilities of NT$2.76b due beyond that. On the other hand, it had cash of NT$2.61b and NT$412.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$5.23b.

While this might seem like a lot, it is not so bad since Wowprime has a market capitalization of NT$10.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Wowprime boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Wowprime's saving grace is its low debt levels, because its EBIT has tanked 30% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Wowprime can strengthen its balance sheet over time. 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. Wowprime 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, Wowprime 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

While Wowprime does have more liabilities than liquid assets, it also has net cash of NT$2.39b. And it impressed us with free cash flow of NT$1.5b, being 141% of its EBIT. So we are not troubled with Wowprime's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Wowprime that you should be aware of before investing here.

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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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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