These 4 Measures Indicate That Weltrend Semiconductor (TWSE:2436) Is Using Debt Safely

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 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 note that Weltrend Semiconductor, Inc. (TWSE:2436) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Weltrend Semiconductor

What Is Weltrend Semiconductor's Debt?

As you can see below, at the end of September 2024, Weltrend Semiconductor had NT$1.37b of debt, up from NT$1.20b a year ago. Click the image for more detail. But it also has NT$2.14b in cash to offset that, meaning it has NT$767.5m net cash.

A Look At Weltrend Semiconductor's Liabilities

The latest balance sheet data shows that Weltrend Semiconductor had liabilities of NT$1.89b due within a year, and liabilities of NT$181.0m falling due after that. Offsetting this, it had NT$2.14b in cash and NT$1.06b in receivables that were due within 12 months. So it can boast NT$1.12b more liquid assets than total liabilities.

This short term liquidity is a sign that Weltrend Semiconductor could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Weltrend Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Weltrend Semiconductor made a loss at the EBIT level, last year, it was also good to see that it generated NT$185m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Weltrend Semiconductor will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Weltrend Semiconductor 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, Weltrend Semiconductor 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Weltrend Semiconductor has NT$767.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$581m, being 313% of its EBIT. So is Weltrend Semiconductor'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. However, not all investment risk resides within the balance sheet - far from it. For example Weltrend Semiconductor has 3 warning signs (and 1 which is significant) 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. 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.