Is Emerging Display Technologies (TPE:3038) 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.' 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. We can see that Emerging Display Technologies Corp. (TPE:3038) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Emerging Display Technologies

What Is Emerging Display Technologies's Net Debt?

As you can see below, Emerging Display Technologies had NT$700.0m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds NT$1.46b in cash, so it actually has NT$760.9m net cash.

How Healthy Is Emerging Display Technologies' Balance Sheet?

According to the last reported balance sheet, Emerging Display Technologies had liabilities of NT$1.48b due within 12 months, and liabilities of NT$150.5m due beyond 12 months. Offsetting these obligations, it had cash of NT$1.46b as well as receivables valued at NT$592.5m due within 12 months. So it can boast NT$424.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Emerging Display Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Emerging Display Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Emerging Display Technologies grew its EBIT by 6.2% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Emerging Display Technologies'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Emerging Display Technologies 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. Happily for any shareholders, Emerging Display Technologies actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Emerging Display Technologies has NT$760.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$162m, being 102% of its EBIT. So is Emerging Display Technologies'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. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Emerging Display Technologies is showing 2 warning signs in our investment analysis , you should know about...

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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