FocalTech Systems (TPE:3545) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 FocalTech Systems Co., Ltd. (TPE:3545) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for FocalTech Systems

How Much Debt Does FocalTech Systems Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 FocalTech Systems had NT$523.6m of debt, an increase on none, over one year. However, it does have NT$5.40b in cash offsetting this, leading to net cash of NT$4.87b.

A Look At FocalTech Systems' Liabilities

The latest balance sheet data shows that FocalTech Systems had liabilities of NT$3.96b due within a year, and liabilities of NT$577.3m falling due after that. On the other hand, it had cash of NT$5.40b and NT$1.64b worth of receivables due within a year. So it actually has NT$2.50b more liquid assets than total liabilities.

This short term liquidity is a sign that FocalTech Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, FocalTech Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, FocalTech Systems turned things around in the last 12 months, delivering and EBIT of NT$1.0b. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if FocalTech Systems 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. FocalTech Systems 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. During the last year, FocalTech Systems produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case FocalTech Systems has NT$4.87b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$704m, being 68% of its EBIT. So is FocalTech Systems'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for FocalTech Systems 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.

When trading FocalTech Systems or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.