Is E Ink Holdings (GTSM:8069) A Risky Investment?

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.' 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. Importantly, E Ink Holdings Inc. (GTSM:8069) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for E Ink Holdings

How Much Debt Does E Ink Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2020 E Ink Holdings had debt of NT$6.26b, up from NT$5.14b in one year. But on the other hand it also has NT$15.8b in cash, leading to a NT$9.57b net cash position.

How Healthy Is E Ink Holdings' Balance Sheet?

The latest balance sheet data shows that E Ink Holdings had liabilities of NT$11.6b due within a year, and liabilities of NT$3.19b falling due after that. Offsetting this, it had NT$15.8b in cash and NT$1.59b in receivables that were due within 12 months. So it can boast NT$2.66b more liquid assets than total liabilities.

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

Better yet, E Ink Holdings grew its EBIT by 229% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 E Ink Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. E Ink Holdings 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 three years, E Ink Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that E Ink Holdings has net cash of NT$9.57b, as well as more liquid assets than liabilities. The cherry on top was that in converted 304% of that EBIT to free cash flow, bringing in NT$4.1b. So is E Ink Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that E Ink Holdings is showing 1 warning sign in our investment analysis , 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. 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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