HannStar Display (TPE:6116) Seems To Use Debt Quite Sensibly

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.' 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 HannStar Display Corporation (TPE:6116) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for HannStar Display

What Is HannStar Display's Net Debt?

You can click the graphic below for the historical numbers, but it shows that HannStar Display had NT$775.0m of debt in September 2020, down from NT$831.8m, one year before. But it also has NT$16.1b in cash to offset that, meaning it has NT$15.3b net cash.

How Healthy Is HannStar Display's Balance Sheet?

We can see from the most recent balance sheet that HannStar Display had liabilities of NT$7.87b falling due within a year, and liabilities of NT$559.6m due beyond that. Offsetting these obligations, it had cash of NT$16.1b as well as receivables valued at NT$1.77b due within 12 months. So it can boast NT$9.46b more liquid assets than total liabilities.

It's good to see that HannStar Display has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that HannStar Display has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, HannStar Display turned things around in the last 12 months, delivering and EBIT of NT$919m. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HannStar Display will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. HannStar Display 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 last year, HannStar Display reported free cash flow worth 4.2% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case HannStar Display has NT$15.3b in net cash and a decent-looking balance sheet. So we don't have any problem with HannStar Display's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for HannStar Display 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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