These 4 Measures Indicate That Eson Precision Ind (TPE:5243) Is Using Debt Safely

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Eson Precision Ind. Co., Ltd. (TPE:5243) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, 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.

View our latest analysis for Eson Precision Ind

What Is Eson Precision Ind's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Eson Precision Ind had debt of NT$494.7m, up from NT$248.3m in one year. But it also has NT$3.36b in cash to offset that, meaning it has NT$2.87b net cash.

How Strong Is Eson Precision Ind's Balance Sheet?

The latest balance sheet data shows that Eson Precision Ind had liabilities of NT$3.75b due within a year, and liabilities of NT$118.0m falling due after that. Offsetting this, it had NT$3.36b in cash and NT$2.29b in receivables that were due within 12 months. So it actually has NT$1.77b more liquid assets than total liabilities.

It's good to see that Eson Precision Ind has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Eson Precision Ind has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Eson Precision Ind saw its EBIT decline by 9.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Eson Precision Ind can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Eson Precision Ind 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. Happily for any shareholders, Eson Precision Ind actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Eson Precision Ind has NT$2.87b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in NT$41m. So is Eson Precision Ind's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Eson Precision Ind that you should be aware of before investing here.

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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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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