Lotes (TPE:3533) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Lotes Co., Ltd (TPE:3533) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lotes

How Much Debt Does Lotes Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Lotes had debt of NT$782.0m, up from NT$286.7m in one year. However, it does have NT$4.04b in cash offsetting this, leading to net cash of NT$3.26b.

A Look At Lotes' Liabilities

Zooming in on the latest balance sheet data, we can see that Lotes had liabilities of NT$5.32b due within 12 months and liabilities of NT$273.6m due beyond that. On the other hand, it had cash of NT$4.04b and NT$6.90b worth of receivables due within a year. So it actually has NT$5.35b more liquid assets than total liabilities.

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

On top of that, Lotes grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lotes'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 company can only pay off debt with cold hard cash, not accounting profits. While Lotes 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. During the last three years, Lotes produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Lotes has NT$3.26b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 51% over the last year. So is Lotes's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Lotes you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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