Is Rectron (TPE:2302) Using Too Much Debt?

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 Rectron Limited (TPE:2302) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Rectron

What Is Rectron's Debt?

As you can see below, at the end of September 2020, Rectron had NT$157.0m of debt, up from NT$147.0m a year ago. Click the image for more detail. However, it does have NT$382.4m in cash offsetting this, leading to net cash of NT$225.4m.

A Look At Rectron's Liabilities

According to the last reported balance sheet, Rectron had liabilities of NT$480.7m due within 12 months, and liabilities of NT$78.8m due beyond 12 months. Offsetting these obligations, it had cash of NT$382.4m as well as receivables valued at NT$145.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$31.7m.

Having regard to Rectron's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NT$3.46b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Rectron also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Rectron grew its EBIT by 390% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is Rectron's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Rectron 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. Happily for any shareholders, Rectron actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Rectron has NT$225.4m in net cash. The cherry on top was that in converted 490% of that EBIT to free cash flow, bringing in NT$188m. So is Rectron's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Rectron (of which 1 shouldn't be ignored!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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