Is SINBON Electronics (TPE:3023) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies SINBON Electronics Co., Ltd. (TPE:3023) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for SINBON Electronics

What Is SINBON Electronics's Debt?

As you can see below, at the end of December 2020, SINBON Electronics had NT$4.63b of debt, up from NT$2.75b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$4.70b in cash, so it actually has NT$71.8m net cash.

How Strong Is SINBON Electronics' Balance Sheet?

The latest balance sheet data shows that SINBON Electronics had liabilities of NT$11.8b due within a year, and liabilities of NT$2.12b falling due after that. Offsetting these obligations, it had cash of NT$4.70b as well as receivables valued at NT$7.86b due within 12 months. So its liabilities total NT$1.35b more than the combination of its cash and short-term receivables.

Since publicly traded SINBON Electronics shares are worth a total of NT$61.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, SINBON Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that SINBON Electronics has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SINBON Electronics's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. SINBON Electronics 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. Looking at the most recent three years, SINBON Electronics recorded free cash flow of 24% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that SINBON Electronics has NT$71.8m in net cash. And it impressed us with its EBIT growth of 40% over the last year. So is SINBON Electronics's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 3 warning signs we've spotted with SINBON Electronics (including 2 which don't sit too well with us) .

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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