These 4 Measures Indicate That Chicony Electronics (TWSE:2385) Is Using Debt Safely

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.' 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 Chicony Electronics Co., Ltd. (TWSE:2385) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 Chicony Electronics

What Is Chicony Electronics's Debt?

As you can see below, at the end of September 2024, Chicony Electronics had NT$4.85b of debt, up from NT$3.95b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$28.1b in cash, so it actually has NT$23.3b net cash.

How Healthy Is Chicony Electronics' Balance Sheet?

The latest balance sheet data shows that Chicony Electronics had liabilities of NT$48.4b due within a year, and liabilities of NT$682.8m falling due after that. Offsetting this, it had NT$28.1b in cash and NT$28.1b in receivables that were due within 12 months. So it actually has NT$7.15b more liquid assets than total liabilities.

This surplus suggests that Chicony Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Chicony Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Chicony Electronics grew its EBIT by 14% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Chicony Electronics's ability to maintain a healthy balance sheet going forward. 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 Chicony Electronics 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, Chicony Electronics actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Chicony Electronics has net cash of NT$23.3b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$8.8b, being 118% of its EBIT. So is Chicony Electronics's debt a risk? It doesn't seem so to us. Given Chicony Electronics has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.