Is AboCom Systems (TPE:2444) Using Too Much 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that AboCom Systems, Inc. (TPE:2444) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for AboCom Systems

What Is AboCom Systems's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 AboCom Systems had NT$487.3m of debt, an increase on NT$409.6m, over one year. However, it also had NT$209.1m in cash, and so its net debt is NT$278.2m.

How Strong Is AboCom Systems' Balance Sheet?

We can see from the most recent balance sheet that AboCom Systems had liabilities of NT$1.02b falling due within a year, and liabilities of NT$1.89m due beyond that. Offsetting these obligations, it had cash of NT$209.1m as well as receivables valued at NT$284.1m due within 12 months. So it has liabilities totalling NT$525.3m more than its cash and near-term receivables, combined.

AboCom Systems has a market capitalization of NT$1.48b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is AboCom Systems'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, AboCom Systems reported revenue of NT$1.7b, which is a gain of 18%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months AboCom Systems produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$71m 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. We would feel better if it turned its trailing twelve month loss of NT$85m into a profit. So to be blunt we do think it is risky. 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. Take risks, for example - AboCom Systems has 2 warning signs (and 1 which is potentially serious) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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