Is Compeq Manufacturing (TWSE:2313) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Compeq Manufacturing Co., Ltd. (TWSE:2313) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Compeq Manufacturing

How Much Debt Does Compeq Manufacturing Carry?

As you can see below, at the end of June 2024, Compeq Manufacturing had NT$15.3b of debt, up from NT$14.3b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$18.8b in cash, so it actually has NT$3.49b net cash.

How Healthy Is Compeq Manufacturing's Balance Sheet?

According to the last reported balance sheet, Compeq Manufacturing had liabilities of NT$25.7b due within 12 months, and liabilities of NT$15.1b due beyond 12 months. On the other hand, it had cash of NT$18.8b and NT$15.0b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.06b.

Given Compeq Manufacturing has a market capitalization of NT$76.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Compeq Manufacturing boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Compeq Manufacturing's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Compeq Manufacturing 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Compeq Manufacturing 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. In the last three years, Compeq Manufacturing's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Compeq Manufacturing has NT$3.49b in net cash. So we are not troubled with Compeq Manufacturing's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Compeq Manufacturing you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.