These 4 Measures Indicate That Chicony Electronics (TPE:2385) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Chicony Electronics Co., Ltd. (TPE:2385) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Chicony Electronics

What Is Chicony Electronics's Debt?

As you can see below, Chicony Electronics had NT$88.2m of debt at December 2020, down from NT$995.0m a year prior. However, its balance sheet shows it holds NT$9.78b in cash, so it actually has NT$9.69b net cash.

How Healthy Is Chicony Electronics' Balance Sheet?

We can see from the most recent balance sheet that Chicony Electronics had liabilities of NT$41.6b falling due within a year, and liabilities of NT$1.14b due beyond that. Offsetting this, it had NT$9.78b in cash and NT$24.0b in receivables that were due within 12 months. So it has liabilities totalling NT$8.99b more than its cash and near-term receivables, combined.

Of course, Chicony Electronics has a market capitalization of NT$67.8b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Chicony Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Chicony Electronics has been able to increase its EBIT by 22% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Chicony Electronics'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 company can only pay off debt with cold hard cash, not accounting profits. Chicony Electronics 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, Chicony Electronics recorded free cash flow worth a fulsome 93% 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 Chicony Electronics'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$9.69b. The cherry on top was that in converted 93% of that EBIT to free cash flow, bringing in NT$4.9b. So we don't think Chicony Electronics's use of debt is risky. Given Chicony Electronics has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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