David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Eastern Media International Corporation (TPE:2614) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Eastern Media International Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Eastern Media International had NT$803.9m of debt, an increase on NT$224.3m, over one year. But on the other hand it also has NT$1.79b in cash, leading to a NT$986.7m net cash position.
A Look At Eastern Media International's Liabilities
The latest balance sheet data shows that Eastern Media International had liabilities of NT$2.39b due within a year, and liabilities of NT$6.83b falling due after that. Offsetting this, it had NT$1.79b in cash and NT$624.5m in receivables that were due within 12 months. So its liabilities total NT$6.81b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of NT$9.21b, so it does suggest shareholders should keep an eye on Eastern Media International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Eastern Media International also has more cash than debt, so we're pretty confident it can manage its debt safely.
Importantly, Eastern Media International's EBIT fell a jaw-dropping 86% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Eastern Media International 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 company can only pay off debt with cold hard cash, not accounting profits. While Eastern Media International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Eastern Media International actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While Eastern Media International does have more liabilities than liquid assets, it also has net cash of NT$986.7m. And it impressed us with free cash flow of NT$1.3b, being 424% of its EBIT. So although we see some areas for improvement, we're not too worried about Eastern Media International's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Eastern Media International has 2 warning signs we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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