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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that AIC Inc. (GTSM:3693) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.
View our latest analysis for AIC
What Is AIC's Net Debt?
As you can see below, AIC had NT$345.3m of debt at September 2020, down from NT$370.0m a year prior. However, it does have NT$473.7m in cash offsetting this, leading to net cash of NT$128.4m.
How Strong Is AIC's Balance Sheet?
We can see from the most recent balance sheet that AIC had liabilities of NT$1.16b falling due within a year, and liabilities of NT$125.6m due beyond that. On the other hand, it had cash of NT$473.7m and NT$556.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$253.9m.
Given AIC has a market capitalization of NT$1.88b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, AIC boasts net cash, so it's fair to say it does not have a heavy debt load!
Although AIC made a loss at the EBIT level, last year, it was also good to see that it generated NT$154m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since AIC 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. AIC 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 year, AIC recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
Although AIC's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$128.4m. And it impressed us with free cash flow of NT$149m, being 97% of its EBIT. So we don't think AIC's use of debt is risky. 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 for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with AIC (at least 1 which is significant) , and understanding them should be part of your investment process.
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. 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.
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About TPEX:3693
AIC
Provides OEM/ODM, commercial off-the-shelf, and server and storage solutions in the United States, Asia, and Europe.
Flawless balance sheet average dividend payer.
