Here's Why Sercomm (TPE:5388) Can Manage Its Debt Responsibly

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.' 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. We can see that Sercomm Corporation (TPE:5388) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 Sercomm

What Is Sercomm's Debt?

As you can see below, at the end of September 2020, Sercomm had NT$5.17b of debt, up from NT$3.55b a year ago. Click the image for more detail. But it also has NT$6.65b in cash to offset that, meaning it has NT$1.48b net cash.

How Healthy Is Sercomm's Balance Sheet?

According to the last reported balance sheet, Sercomm had liabilities of NT$16.5b due within 12 months, and liabilities of NT$4.02b due beyond 12 months. On the other hand, it had cash of NT$6.65b and NT$7.85b worth of receivables due within a year. So it has liabilities totalling NT$6.02b more than its cash and near-term receivables, combined.

Sercomm has a market capitalization of NT$17.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Sercomm also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Sercomm saw its EBIT drop by 7.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sercomm 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sercomm 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. Looking at the most recent three years, Sercomm recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Sercomm'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$1.48b. So we don't have any problem with Sercomm's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Sercomm (including 2 which are a bit concerning) .

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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