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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that ASM Pacific Technology Limited (HKG:522) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for ASM Pacific Technology
What Is ASM Pacific Technology's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 ASM Pacific Technology had HK$3.37b of debt, an increase on HK$3.07b, over one year. However, it does have HK$2.51b in cash offsetting this, leading to net debt of about HK$856.5m.
A Look At ASM Pacific Technology's Liabilities
According to the last reported balance sheet, ASM Pacific Technology had liabilities of HK$5.08b due within 12 months, and liabilities of HK$4.89b due beyond 12 months. On the other hand, it had cash of HK$2.51b and HK$4.82b worth of receivables due within a year. So its liabilities total HK$2.64b more than the combination of its cash and short-term receivables.
Given ASM Pacific Technology has a market capitalization of HK$40.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
ASM Pacific Technology has a low net debt to EBITDA ratio of only 0.35. And its EBIT easily covers its interest expense, being 10.9 times the size. So we're pretty relaxed about its super-conservative use of debt. The modesty of its debt load may become crucial for ASM Pacific Technology if management cannot prevent a repeat of the 49% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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.