Is Alpha Networks (TPE:3380) 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. Importantly, Alpha Networks Inc. (TPE:3380) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alpha Networks

How Much Debt Does Alpha Networks Carry?

As you can see below, at the end of December 2020, Alpha Networks had NT$3.37b of debt, up from NT$1.79b a year ago. Click the image for more detail. But it also has NT$5.92b in cash to offset that, meaning it has NT$2.55b net cash.

How Healthy Is Alpha Networks' Balance Sheet?

We can see from the most recent balance sheet that Alpha Networks had liabilities of NT$13.7b falling due within a year, and liabilities of NT$552.1m due beyond that. Offsetting these obligations, it had cash of NT$5.92b as well as receivables valued at NT$6.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.47b.

Given Alpha Networks has a market capitalization of NT$19.5b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Alpha Networks boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Alpha Networks grew its EBIT by 288% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Alpha Networks can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Alpha Networks 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. Over the last two years, Alpha Networks saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Alpha Networks has NT$2.55b in net cash. And it impressed us with its EBIT growth of 288% over the last year. So we don't have any problem with Alpha Networks's use of debt. 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. For instance, we've identified 1 warning sign for Alpha Networks that 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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