Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We note that Ventec International Group Co.,Ltd. (TPE:6672) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Ventec International GroupLtd's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 Ventec International GroupLtd had debt of NT$427.6m, up from NT$399.7m in one year. However, it does have NT$898.0m in cash offsetting this, leading to net cash of NT$470.4m.
A Look At Ventec International GroupLtd's Liabilities
According to the last reported balance sheet, Ventec International GroupLtd had liabilities of NT$1.59b due within 12 months, and liabilities of NT$383.4m due beyond 12 months. Offsetting these obligations, it had cash of NT$898.0m as well as receivables valued at NT$1.33b due within 12 months. So it can boast NT$260.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Ventec International GroupLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ventec International GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Ventec International GroupLtd has increased its EBIT by 4.7% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Ventec International GroupLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Ventec International GroupLtd 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 last three years, Ventec International GroupLtd recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Ventec International GroupLtd has net cash of NT$470.4m, as well as more liquid assets than liabilities. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in NT$569m. So we don't think Ventec International GroupLtd's use of debt is risky. 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. We've identified 2 warning signs with Ventec International GroupLtd , 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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