Is Sigurd Microelectronics (TPE:6257) Using Too Much Debt?

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 can see that Sigurd Microelectronics Corporation (TPE:6257) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Sigurd Microelectronics

What Is Sigurd Microelectronics's Net Debt?

As you can see below, at the end of September 2020, Sigurd Microelectronics had NT$10.4b of debt, up from NT$6.33b a year ago. Click the image for more detail. However, it does have NT$8.94b in cash offsetting this, leading to net debt of about NT$1.48b.

How Healthy Is Sigurd Microelectronics' Balance Sheet?

According to the last reported balance sheet, Sigurd Microelectronics had liabilities of NT$8.42b due within 12 months, and liabilities of NT$5.48b due beyond 12 months. Offsetting these obligations, it had cash of NT$8.94b as well as receivables valued at NT$3.42b due within 12 months. So it has liabilities totalling NT$1.54b more than its cash and near-term receivables, combined.

Of course, Sigurd Microelectronics has a market capitalization of NT$21.7b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sigurd Microelectronics has a low net debt to EBITDA ratio of only 0.28. And its EBIT covers its interest expense a whopping 138 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Sigurd Microelectronics grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sigurd Microelectronics's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Sigurd Microelectronics actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Sigurd Microelectronics's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Taking all this data into account, it seems to us that Sigurd Microelectronics takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example, we've discovered 4 warning signs for Sigurd Microelectronics (1 is significant!) that you should be aware of before investing here.

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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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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