Here's Why Champion Microelectronic (TWSE:3257) Can Manage Its Debt Responsibly

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.' 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 Champion Microelectronic Corporation (TWSE:3257) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Champion Microelectronic

What Is Champion Microelectronic's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Champion Microelectronic had NT$340.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds NT$699.8m in cash, so it actually has NT$359.8m net cash.

How Healthy Is Champion Microelectronic's Balance Sheet?

We can see from the most recent balance sheet that Champion Microelectronic had liabilities of NT$492.5m falling due within a year, and liabilities of NT$17.8m due beyond that. Offsetting these obligations, it had cash of NT$699.8m as well as receivables valued at NT$224.3m due within 12 months. So it actually has NT$413.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Champion Microelectronic could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Champion Microelectronic boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Champion Microelectronic grew its EBIT by 162% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Champion Microelectronic's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Champion Microelectronic 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. Considering the last three years, Champion Microelectronic actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Champion Microelectronic has net cash of NT$359.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 162% year-on-year EBIT growth. So is Champion Microelectronic's debt a risk? It doesn't seem so to us. 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. Be aware that Champion Microelectronic is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.