Here's Why Clevo (TWSE:2362) Has A Meaningful Debt Burden

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 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. Importantly, Clevo Co. (TWSE:2362) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Clevo

What Is Clevo's Debt?

As you can see below, at the end of September 2024, Clevo had NT$38.7b of debt, up from NT$35.9b a year ago. Click the image for more detail. However, it does have NT$11.9b in cash offsetting this, leading to net debt of about NT$26.8b.

How Healthy Is Clevo's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Clevo had liabilities of NT$16.7b due within 12 months and liabilities of NT$40.6b due beyond that. Offsetting these obligations, it had cash of NT$11.9b as well as receivables valued at NT$4.66b due within 12 months. So its liabilities total NT$40.7b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$32.6b, we think shareholders really should watch Clevo's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Clevo has a rather high debt to EBITDA ratio of 12.7 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. However, one redeeming factor is that Clevo grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Clevo'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Clevo recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Clevo's net debt to EBITDA and level of total liabilities definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Clevo is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Clevo you should be aware of, and 1 of them is potentially serious.

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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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.