Here's Why SYSAGE Technology (TPE:6112) Can Manage Its Debt Responsibly

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. Importantly, SYSAGE Technology Co., Ltd. (TPE:6112) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for SYSAGE Technology

What Is SYSAGE Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 SYSAGE Technology had debt of NT$811.7m, up from NT$391.2m in one year. On the flip side, it has NT$644.5m in cash leading to net debt of about NT$167.2m.

A Look At SYSAGE Technology's Liabilities

We can see from the most recent balance sheet that SYSAGE Technology had liabilities of NT$3.11b falling due within a year, and liabilities of NT$487.3m due beyond that. On the other hand, it had cash of NT$644.5m and NT$2.56b worth of receivables due within a year. So its liabilities total NT$387.2m more than the combination of its cash and short-term receivables.

Since publicly traded SYSAGE Technology shares are worth a total of NT$7.55b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

SYSAGE Technology's net debt is only 0.25 times its EBITDA. And its EBIT easily covers its interest expense, being 80.4 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that SYSAGE Technology has boosted its EBIT by 37%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine SYSAGE Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, SYSAGE Technology 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.

Our View

The good news is that SYSAGE Technology's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. When we consider the range of factors above, it looks like SYSAGE Technology is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for SYSAGE Technology you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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