Is Abonmax (TPE:2429) A Risky Investment?

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.' 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 can see that Abonmax Co., Ltd (TPE:2429) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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, 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.

View our latest analysis for Abonmax

What Is Abonmax's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Abonmax had NT$485.4m of debt, an increase on NT$339.1m, over one year. However, it also had NT$172.3m in cash, and so its net debt is NT$313.1m.

How Healthy Is Abonmax's Balance Sheet?

The latest balance sheet data shows that Abonmax had liabilities of NT$431.2m due within a year, and liabilities of NT$227.1m falling due after that. Offsetting these obligations, it had cash of NT$172.3m as well as receivables valued at NT$96.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$389.3m.

This deficit isn't so bad because Abonmax is worth NT$703.5m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Abonmax's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Abonmax made a loss at the EBIT level, and saw its revenue drop to NT$900m, which is a fall of 7.4%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Abonmax produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at NT$60m. 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. For example, we would not want to see a repeat of last year's loss of NT$61m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Abonmax (at least 1 which is significant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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