Does Merry Electronics (TPE:2439) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Merry Electronics Co., Ltd. (TPE:2439) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Merry Electronics

What Is Merry Electronics's Net Debt?

As you can see below, at the end of September 2020, Merry Electronics had NT$5.24b of debt, up from NT$4.91b a year ago. Click the image for more detail. However, it does have NT$5.31b in cash offsetting this, leading to net cash of NT$74.8m.

How Healthy Is Merry Electronics' Balance Sheet?

We can see from the most recent balance sheet that Merry Electronics had liabilities of NT$16.0b falling due within a year, and liabilities of NT$3.88b due beyond that. Offsetting these obligations, it had cash of NT$5.31b as well as receivables valued at NT$10.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.97b.

Given Merry Electronics has a market capitalization of NT$30.9b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Merry Electronics 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 Merry Electronics if management cannot prevent a repeat of the 71% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Merry Electronics 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. While Merry Electronics has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Merry Electronics's free cash flow amounted to 44% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While Merry Electronics does have more liabilities than liquid assets, it also has net cash of NT$74.8m. So we don't have any problem with Merry Electronics's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Merry Electronics has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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