Here's Why Ichia Technologies (TPE:2402) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Ichia Technologies, Inc. (TPE:2402) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ichia Technologies

What Is Ichia Technologies's Net Debt?

As you can see below, at the end of September 2020, Ichia Technologies had NT$1.39b of debt, up from NT$1.21b a year ago. Click the image for more detail. But it also has NT$1.79b in cash to offset that, meaning it has NT$401.4m net cash.

How Healthy Is Ichia Technologies' Balance Sheet?

The latest balance sheet data shows that Ichia Technologies had liabilities of NT$2.89b due within a year, and liabilities of NT$176.6m falling due after that. Offsetting these obligations, it had cash of NT$1.79b as well as receivables valued at NT$1.98b due within 12 months. So it can boast NT$703.7m more liquid assets than total liabilities.

This surplus suggests that Ichia Technologies has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Ichia Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Ichia Technologies if management cannot prevent a repeat of the 34% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Ichia Technologies'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ichia Technologies 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 two years, Ichia Technologies actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Ichia Technologies has NT$401.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$667m, being 283% of its EBIT. So we don't have any problem with Ichia Technologies's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Ichia Technologies you should know about.

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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