Is Advantech (TPE:2395) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Advantech Co., Ltd. (TPE:2395) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Advantech

What Is Advantech's Net Debt?

As you can see below, Advantech had NT$293.2m of debt at September 2020, down from NT$344.3m a year prior. However, its balance sheet shows it holds NT$9.79b in cash, so it actually has NT$9.50b net cash.

How Strong Is Advantech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Advantech had liabilities of NT$11.6b due within 12 months and liabilities of NT$3.11b due beyond that. Offsetting these obligations, it had cash of NT$9.79b as well as receivables valued at NT$8.89b due within 12 months. So it actually has NT$3.94b more liquid assets than total liabilities.

This state of affairs indicates that Advantech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$269.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Advantech has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Advantech has increased its EBIT by 4.5% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Advantech can strengthen its balance sheet over time. 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. Advantech 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 most recent three years, Advantech recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Advantech has net cash of NT$9.50b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$7.2b, being 69% of its EBIT. So is Advantech's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Advantech, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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