These 4 Measures Indicate That Lotes (TWSE:3533) Is Using Debt Safely

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. As with many other companies Lotes Co., Ltd (TWSE:3533) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lotes

What Is Lotes's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Lotes had debt of NT$1.88b, up from NT$1.12b in one year. However, it does have NT$17.9b in cash offsetting this, leading to net cash of NT$16.1b.

A Look At Lotes' Liabilities

According to the last reported balance sheet, Lotes had liabilities of NT$11.3b due within 12 months, and liabilities of NT$1.09b due beyond 12 months. Offsetting these obligations, it had cash of NT$17.9b as well as receivables valued at NT$11.4b due within 12 months. So it can boast NT$16.9b more liquid assets than total liabilities.

This short term liquidity is a sign that Lotes could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Lotes has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Lotes grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. 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 Lotes'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, a company can only pay off debt with cold hard cash, not accounting profits. Lotes may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Lotes recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Lotes has net cash of NT$16.1b, as well as more liquid assets than liabilities. And we liked the look of last year's 21% year-on-year EBIT growth. So is Lotes's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Lotes you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.