Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Sunplus Technology Company Limited (TPE:2401) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
View our latest analysis for Sunplus Technology
How Much Debt Does Sunplus Technology Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Sunplus Technology had NT$507.5m of debt, an increase on NT$348.4m, over one year. However, its balance sheet shows it holds NT$3.87b in cash, so it actually has NT$3.36b net cash.
A Look At Sunplus Technology’s Liabilities
We can see from the most recent balance sheet that Sunplus Technology had liabilities of NT$1.67b falling due within a year, and liabilities of NT$778.6m due beyond that. Offsetting this, it had NT$3.87b in cash and NT$1.24b in receivables that were due within 12 months. So it actually has NT$2.66b more liquid assets than total liabilities.
This excess liquidity suggests that Sunplus Technology is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Sunplus Technology boasts net cash, so it’s fair to say it does not have a heavy debt load!
Better yet, Sunplus Technology grew its EBIT by 259% last year, which is an impressive improvement. That boost will make it even 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 Sunplus Technology’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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sunplus Technology 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 two years, Sunplus Technology actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company’s debt, in this case Sunplus Technology has NT$3.36b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 158% of that EBIT to free cash flow, bringing in NT$332m. The bottom line is that we do not find Sunplus Technology’s debt levels at all concerning. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sunplus Technology is showing 2 warning signs in our investment analysis , and 1 of those can’t be ignored…
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. 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.
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