We Think Phison Electronics (GTSM:8299) Can Manage Its Debt With Ease

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Phison Electronics Corp. (GTSM:8299) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Phison Electronics

How Much Debt Does Phison Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Phison Electronics had debt of NT$991.2m, up from none in one year. However, its balance sheet shows it holds NT$16.5b in cash, so it actually has NT$15.5b net cash.

A Look At Phison Electronics' Liabilities

The latest balance sheet data shows that Phison Electronics had liabilities of NT$9.32b due within a year, and liabilities of NT$433.4m falling due after that. On the other hand, it had cash of NT$16.5b and NT$5.88b worth of receivables due within a year. So it actually has NT$12.6b more liquid assets than total liabilities.

It's good to see that Phison Electronics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Phison Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Phison Electronics grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Phison Electronics can strengthen its balance sheet over time. 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. While Phison Electronics 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. During the last three years, Phison Electronics produced sturdy free cash flow equating to 57% 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

While we empathize with investors who find debt concerning, you should keep in mind that Phison Electronics has net cash of NT$15.5b, as well as more liquid assets than liabilities. And it also grew its EBIT by 13% over the last year. So is Phison Electronics's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Phison Electronics (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

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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