Here's Why Primax Electronics (TPE:4915) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Primax Electronics Ltd. (TPE:4915) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Primax Electronics

What Is Primax Electronics's Debt?

The image below, which you can click on for greater detail, shows that Primax Electronics had debt of NT$6.89b at the end of September 2020, a reduction from NT$8.34b over a year. But on the other hand it also has NT$10.8b in cash, leading to a NT$3.95b net cash position.

How Strong Is Primax Electronics's Balance Sheet?

According to the last reported balance sheet, Primax Electronics had liabilities of NT$31.2b due within 12 months, and liabilities of NT$4.20b due beyond 12 months. Offsetting this, it had NT$10.8b in cash and NT$15.9b in receivables that were due within 12 months. So its liabilities total NT$8.67b more than the combination of its cash and short-term receivables.

Primax Electronics has a market capitalization of NT$21.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Primax Electronics also has more cash than debt, so we're pretty confident it can manage its debt safely.

Primax Electronics's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Primax Electronics's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Primax Electronics 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 most recent three years, Primax Electronics recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Primax Electronics does have more liabilities than liquid assets, it also has net cash of NT$3.95b. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in NT$6.6b. So we don't have any problem with Primax Electronics's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Primax Electronics .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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