Would Universal Microelectronics (TPE:2413) Be Better Off With Less Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Universal Microelectronics Co., Ltd. (TPE:2413) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Universal Microelectronics

What Is Universal Microelectronics's Debt?

As you can see below, Universal Microelectronics had NT$2.10b of debt at September 2020, down from NT$2.24b a year prior. However, it does have NT$981.9m in cash offsetting this, leading to net debt of about NT$1.12b.

How Strong Is Universal Microelectronics' Balance Sheet?

We can see from the most recent balance sheet that Universal Microelectronics had liabilities of NT$1.99b falling due within a year, and liabilities of NT$1.14b due beyond that. Offsetting these obligations, it had cash of NT$981.9m as well as receivables valued at NT$794.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.35b.

Universal Microelectronics has a market capitalization of NT$2.86b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Universal Microelectronics's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Universal Microelectronics saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Over the last twelve months Universal Microelectronics produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$59m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled NT$203m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Universal Microelectronics you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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