Is Alpha Networks (TPE:3380) 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.' 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. As with many other companies Alpha Networks Inc. (TPE:3380) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alpha Networks

How Much Debt Does Alpha Networks Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Alpha Networks had debt of NT$3.64b, up from none in one year. But on the other hand it also has NT$5.34b in cash, leading to a NT$1.70b net cash position.

A Look At Alpha Networks's Liabilities

Zooming in on the latest balance sheet data, we can see that Alpha Networks had liabilities of NT$13.1b due within 12 months and liabilities of NT$1.18b due beyond that. On the other hand, it had cash of NT$5.34b and NT$7.13b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.78b.

Since publicly traded Alpha Networks shares are worth a total of NT$16.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Alpha Networks also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Alpha Networks grew its EBIT by 243% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Alpha Networks will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Alpha Networks 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. Over the last two years, Alpha Networks saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

Although Alpha Networks's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$1.70b. And we liked the look of last year's 243% year-on-year EBIT growth. So we don't have any problem with Alpha Networks's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Alpha Networks has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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