Here's Why Innolux (TPE:3481) Can Manage Its Debt Responsibly

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.' 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 Innolux Corporation (TPE:3481) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Innolux

What Is Innolux's Debt?

As you can see below, at the end of December 2020, Innolux had NT$45.1b of debt, up from NT$35.7b a year ago. Click the image for more detail. But on the other hand it also has NT$69.2b in cash, leading to a NT$24.1b net cash position.

How Strong Is Innolux's Balance Sheet?

We can see from the most recent balance sheet that Innolux had liabilities of NT$109.2b falling due within a year, and liabilities of NT$32.8b due beyond that. On the other hand, it had cash of NT$69.2b and NT$55.1b worth of receivables due within a year. So its liabilities total NT$17.7b more than the combination of its cash and short-term receivables.

Since publicly traded Innolux shares are worth a total of NT$200.8b, 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, Innolux boasts net cash, so it's fair to say it does not have a heavy debt load!

Notably, Innolux made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$1.8b in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Innolux 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Innolux 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 year, Innolux recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Innolux's liabilities, but we can be reassured by the fact it has has net cash of NT$24.1b. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in NT$1.7b. So we are not troubled with Innolux's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Innolux that you should be aware of before investing here.

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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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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