ASMedia Technology (TPE:5269) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that ASMedia Technology Inc. (TPE:5269) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ASMedia Technology

How Much Debt Does ASMedia Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 ASMedia Technology had NT$187.5m of debt, an increase on none, over one year. However, its balance sheet shows it holds NT$2.40b in cash, so it actually has NT$2.21b net cash.

How Healthy Is ASMedia Technology's Balance Sheet?

According to the last reported balance sheet, ASMedia Technology had liabilities of NT$1.31b due within 12 months, and liabilities of NT$26.4m due beyond 12 months. Offsetting these obligations, it had cash of NT$2.40b as well as receivables valued at NT$1.11b due within 12 months. So it actually has NT$2.17b more liquid assets than total liabilities.

This state of affairs indicates that ASMedia Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$110.1b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that ASMedia Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, ASMedia Technology grew its EBIT by 76% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ASMedia Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ASMedia 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, ASMedia Technology generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case ASMedia Technology has NT$2.21b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in NT$1.3b. So is ASMedia Technology'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. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for ASMedia Technology (of which 1 is concerning!) you should know about.

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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