These 4 Measures Indicate That Primax Electronics (TPE:4915) Is Using Debt Reasonably Well

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.' 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 Primax Electronics Ltd. (TPE:4915) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Primax Electronics

What Is Primax Electronics's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Primax Electronics had debt of NT$1.66b, up from NT$1.27b in one year. But on the other hand it also has NT$8.10b in cash, leading to a NT$6.44b net cash position.

How Strong Is Primax Electronics' Balance Sheet?

We can see from the most recent balance sheet that Primax Electronics had liabilities of NT$27.9b falling due within a year, and liabilities of NT$3.87b due beyond that. On the other hand, it had cash of NT$8.10b and NT$15.1b worth of receivables due within a year. So it has liabilities totalling NT$8.58b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Primax Electronics has a market capitalization of NT$27.5b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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.

But the bad news is that Primax Electronics has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. 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 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 Primax Electronics 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 most recent three years, Primax Electronics recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Primax Electronics'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$6.44b. 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. Case in point: We've spotted 1 warning sign for Primax Electronics you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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