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. We can see that Universal Vision Biotechnology Co., Ltd. (GTSM:3218) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Universal Vision Biotechnology
What Is Universal Vision Biotechnology's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Universal Vision Biotechnology had NT$80.9m of debt in December 2019, down from NT$152.9m, one year before. However, it does have NT$711.1m in cash offsetting this, leading to net cash of NT$630.2m.
How Strong Is Universal Vision Biotechnology's Balance Sheet?
The latest balance sheet data shows that Universal Vision Biotechnology had liabilities of NT$525.7m due within a year, and liabilities of NT$426.1m falling due after that. On the other hand, it had cash of NT$711.1m and NT$385.0m worth of receivables due within a year. So it can boast NT$144.3m more liquid assets than total liabilities.
Having regard to Universal Vision Biotechnology's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$8.11b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Universal Vision Biotechnology boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Universal Vision Biotechnology has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. 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 Universal Vision Biotechnology 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Universal Vision Biotechnology 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. Over the most recent three years, Universal Vision Biotechnology recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
While it is always sensible to investigate a company's debt, in this case Universal Vision Biotechnology has NT$630.2m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 77% over the last year. So we don't think Universal Vision Biotechnology's use of debt is risky. 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 instance, we've identified 1 warning sign for Universal Vision Biotechnology that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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