Is Hon Hai Precision Industry (TPE:2317) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Hon Hai Precision Industry Co., Ltd. (TPE:2317) makes use of debt. But the more important question is: how much risk is that debt creating?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hon Hai Precision Industry

What Is Hon Hai Precision Industry's Debt?

As you can see below, Hon Hai Precision Industry had NT$746.1b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has NT$1.08t in cash to offset that, meaning it has NT$329.0b net cash.

How Strong Is Hon Hai Precision Industry's Balance Sheet?

We can see from the most recent balance sheet that Hon Hai Precision Industry had liabilities of NT$1.74t falling due within a year, and liabilities of NT$235.4b due beyond that. Offsetting these obligations, it had cash of NT$1.08t as well as receivables valued at NT$790.3b due within 12 months. So its liabilities total NT$107.0b more than the combination of its cash and short-term receivables.

Given Hon Hai Precision Industry has a humongous market capitalization of NT$1.22t, 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. While it does have liabilities worth noting, Hon Hai Precision Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Hon Hai Precision Industry's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hon Hai Precision Industry can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hon Hai Precision Industry 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. In the last three years, Hon Hai Precision Industry's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Hon Hai Precision Industry's liabilities, but we can be reassured by the fact it has has net cash of NT$329.0b. So we are not troubled with Hon Hai Precision Industry's debt use. 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 Hon Hai Precision Industry is showing 2 warning signs in our investment analysis , 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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