Here's Why Realtek Semiconductor (TWSE:2379) Can Manage Its Debt Responsibly

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. As with many other companies Realtek Semiconductor Corp. (TWSE:2379) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Realtek Semiconductor

What Is Realtek Semiconductor's Net Debt?

As you can see below, Realtek Semiconductor had NT$6.48b of debt at December 2023, down from NT$15.5b a year prior. But it also has NT$43.6b in cash to offset that, meaning it has NT$37.1b net cash.

How Healthy Is Realtek Semiconductor's Balance Sheet?

According to the last reported balance sheet, Realtek Semiconductor had liabilities of NT$46.2b due within 12 months, and liabilities of NT$5.33b due beyond 12 months. Offsetting this, it had NT$43.6b in cash and NT$13.4b in receivables that were due within 12 months. So it can boast NT$5.39b more liquid assets than total liabilities.

This state of affairs indicates that Realtek Semiconductor'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$294.4b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Realtek Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Realtek Semiconductor's saving grace is its low debt levels, because its EBIT has tanked 58% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Realtek Semiconductor'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. Realtek Semiconductor 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. Over the last three years, Realtek Semiconductor actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Realtek Semiconductor has net cash of NT$37.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$14b, being 110% of its EBIT. So we don't have any problem with Realtek Semiconductor's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Realtek Semiconductor you should be aware of, and 1 of them is potentially serious.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.