Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 Compucase Enterprise Co., Ltd. (TPE:3032) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Compucase Enterprise

How Much Debt Does Compucase Enterprise Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Compucase Enterprise had NT$2.05b of debt, an increase on NT$1.76b, over one year. However, it does have NT$2.51b in cash offsetting this, leading to net cash of NT$457.8m.

TSEC:3032 Debt to Equity History February 23rd 2021

How Healthy Is Compucase Enterprise’s Balance Sheet?

According to the last reported balance sheet, Compucase Enterprise had liabilities of NT$5.60b due within 12 months, and liabilities of NT$113.6m due beyond 12 months. Offsetting this, it had NT$2.51b in cash and NT$2.99b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$212.2m.

Given Compucase Enterprise has a market capitalization of NT$4.86b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Compucase Enterprise also has more cash than debt, so we’re pretty confident it can manage its debt safely.

Better yet, Compucase Enterprise grew its EBIT by 120% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Compucase Enterprise will need earnings to service that debt. 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. Compucase Enterprise 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. In the last three years, Compucase Enterprise created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to look at a company’s total liabilities, it is very reassuring that Compucase Enterprise has NT$457.8m in net cash. And we liked the look of last year’s 120% year-on-year EBIT growth. So we don’t think Compucase Enterprise’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we’ve discovered 2 warning signs for Compucase Enterprise that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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