David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Harvatek Corporation (TPE:6168) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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. 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.
How Much Debt Does Harvatek Carry?
As you can see below, Harvatek had NT$194.0m of debt at September 2020, down from NT$321.5m a year prior. But on the other hand it also has NT$1.29b in cash, leading to a NT$1.10b net cash position.
How Healthy Is Harvatek's Balance Sheet?
The latest balance sheet data shows that Harvatek had liabilities of NT$698.8m due within a year, and liabilities of NT$90.3m falling due after that. Offsetting this, it had NT$1.29b in cash and NT$503.8m in receivables that were due within 12 months. So it actually has NT$1.00b more liquid assets than total liabilities.
This excess liquidity suggests that Harvatek is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Harvatek 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, Harvatek turned things around in the last 12 months, delivering and EBIT of NT$159m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Harvatek 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. While Harvatek 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, Harvatek actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Harvatek has NT$1.10b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$247m, being 156% of its EBIT. So is Harvatek'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. Case in point: We've spotted 2 warning signs for Harvatek you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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