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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Wiwynn Corporation (TPE:6669) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Wiwynn's Debt?
The image below, which you can click on for greater detail, shows that at December 2020 Wiwynn had debt of NT$10.4b, up from NT$8.64b in one year. But it also has NT$23.2b in cash to offset that, meaning it has NT$12.8b net cash.
A Look At Wiwynn's Liabilities
The latest balance sheet data shows that Wiwynn had liabilities of NT$24.8b due within a year, and liabilities of NT$5.41b falling due after that. On the other hand, it had cash of NT$23.2b and NT$9.63b worth of receivables due within a year. So it actually has NT$2.59b more liquid assets than total liabilities.
This state of affairs indicates that Wiwynn's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$145.1b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Wiwynn has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Wiwynn has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. 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 Wiwynn 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. While Wiwynn 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. Looking at the most recent three years, Wiwynn recorded free cash flow of 39% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to investigate a company's debt, in this case Wiwynn has NT$12.8b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 38% over the last year. So is Wiwynn's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Wiwynn , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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