Fitipower Integrated Technology (TPE:4961) Seems To Use Debt Quite Sensibly

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 note that Fitipower Integrated Technology Inc. (TPE:4961) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Fitipower Integrated Technology

How Much Debt Does Fitipower Integrated Technology Carry?

As you can see below, Fitipower Integrated Technology had NT$227.0m of debt at September 2020, down from NT$583.2m a year prior. But on the other hand it also has NT$2.23b in cash, leading to a NT$2.00b net cash position.

How Strong Is Fitipower Integrated Technology's Balance Sheet?

We can see from the most recent balance sheet that Fitipower Integrated Technology had liabilities of NT$2.62b falling due within a year, and liabilities of NT$157.9m due beyond that. Offsetting these obligations, it had cash of NT$2.23b as well as receivables valued at NT$2.69b due within 12 months. So it can boast NT$2.14b more liquid assets than total liabilities.

This surplus suggests that Fitipower Integrated Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Fitipower Integrated Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Fitipower Integrated Technology has seen its EBIT plunge 19% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Fitipower Integrated Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Fitipower Integrated Technology 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 three years, Fitipower Integrated Technology generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Fitipower Integrated Technology has NT$2.00b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in NT$1.2b. So we don't have any problem with Fitipower Integrated Technology's use of debt. 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. We've identified 1 warning sign with Fitipower Integrated Technology , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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