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.' 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. Importantly, ASM Pacific Technology Limited (HKG:522) does carry debt. But is this debt a concern to shareholders?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 ASM Pacific Technology
You can click the graphic below for the historical numbers, but it shows that ASM Pacific Technology had HK$3.13b of debt in June 2021, down from HK$3.69b, one year before. But it also has HK$4.10b in cash to offset that, meaning it has HK$972.6m net cash.
According to the last reported balance sheet, ASM Pacific Technology had liabilities of HK$7.55b due within 12 months, and liabilities of HK$4.34b due beyond 12 months. On the other hand, it had cash of HK$4.10b and HK$5.70b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$2.08b.
Since publicly traded ASM Pacific Technology shares are worth a total of HK$34.4b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, ASM Pacific Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that ASM Pacific Technology has boosted its EBIT by 79%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ASM Pacific Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ASM Pacific Technology 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. Happily for any shareholders, ASM Pacific Technology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about ASM Pacific Technology's liabilities, but we can be reassured by the fact it has has net cash of HK$972.6m. The cherry on top was that in converted 102% of that EBIT to free cash flow, bringing in HK$1.7b. So we don't think ASM Pacific Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet – far from it. For example – ASM Pacific Technology has 2 warning signs we think you should be aware of.
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.
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.
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