Sunplus Technology (TWSE:2401) Has Debt But No Earnings; Should You Worry?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Sunplus Technology Company Limited (TWSE:2401) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sunplus Technology

How Much Debt Does Sunplus Technology Carry?

As you can see below, at the end of December 2023, Sunplus Technology had NT$1.23b of debt, up from NT$1.04b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$5.18b in cash, so it actually has NT$3.96b net cash.

How Healthy Is Sunplus Technology's Balance Sheet?

The latest balance sheet data shows that Sunplus Technology had liabilities of NT$1.71b due within a year, and liabilities of NT$1.44b falling due after that. Offsetting these obligations, it had cash of NT$5.18b as well as receivables valued at NT$877.0m due within 12 months. So it can boast NT$2.90b more liquid assets than total liabilities.

This surplus suggests that Sunplus Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Sunplus Technology boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sunplus Technology 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.

Over 12 months, Sunplus Technology made a loss at the EBIT level, and saw its revenue drop to NT$5.5b, which is a fall of 17%. We would much prefer see growth.

So How Risky Is Sunplus Technology?

Although Sunplus Technology had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of NT$826m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sunplus Technology 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. 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.