Does Compeq Manufacturing (TPE:2313) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Compeq Manufacturing Co., Ltd. (TPE:2313) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Compeq Manufacturing

What Is Compeq Manufacturing's Net Debt?

The chart below, which you can click on for greater detail, shows that Compeq Manufacturing had NT$14.7b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of NT$11.9b, its net debt is less, at about NT$2.81b.

How Healthy Is Compeq Manufacturing's Balance Sheet?

According to the last reported balance sheet, Compeq Manufacturing had liabilities of NT$19.6b due within 12 months, and liabilities of NT$18.0b due beyond 12 months. On the other hand, it had cash of NT$11.9b and NT$14.2b worth of receivables due within a year. So its liabilities total NT$11.5b more than the combination of its cash and short-term receivables.

Compeq Manufacturing has a market capitalization of NT$50.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Compeq Manufacturing's net debt is only 0.25 times its EBITDA. And its EBIT easily covers its interest expense, being 32.5 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Compeq Manufacturing grew its EBIT by 55% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Compeq Manufacturing'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Compeq Manufacturing recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Compeq Manufacturing's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that Compeq Manufacturing takes a pretty sensible approach to debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Compeq Manufacturing is showing 2 warning signs 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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