Does Walton Advanced Engineering (TPE:8110) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Walton Advanced Engineering, Inc. (TPE:8110) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Walton Advanced Engineering

How Much Debt Does Walton Advanced Engineering Carry?

As you can see below, at the end of September 2020, Walton Advanced Engineering had NT$4.15b of debt, up from NT$3.72b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$2.17b, its net debt is less, at about NT$1.98b.

How Healthy Is Walton Advanced Engineering's Balance Sheet?

We can see from the most recent balance sheet that Walton Advanced Engineering had liabilities of NT$3.13b falling due within a year, and liabilities of NT$2.70b due beyond that. Offsetting these obligations, it had cash of NT$2.17b as well as receivables valued at NT$1.31b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.36b.

While this might seem like a lot, it is not so bad since Walton Advanced Engineering has a market capitalization of NT$6.36b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Walton Advanced Engineering has a low debt to EBITDA ratio of only 1.1. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. It was also good to see that despite losing money on the EBIT line last year, Walton Advanced Engineering turned things around in the last 12 months, delivering and EBIT of NT$33m. 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 Walton Advanced Engineering 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Walton Advanced Engineering actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Walton Advanced Engineering's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Taking all this data into account, it seems to us that Walton Advanced Engineering takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. Take risks, for example - Walton Advanced Engineering has 3 warning signs (and 1 which is concerning) we think you should know about.

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.

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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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