Here's Why Goertek (SZSE:002241) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Goertek Inc. (SZSE:002241) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Goertek

What Is Goertek's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Goertek had debt of CN¥17.0b, up from CN¥13.6b in one year. However, it does have CN¥17.0b in cash offsetting this, leading to net cash of CN¥21.5m.

How Healthy Is Goertek's Balance Sheet?

According to the last reported balance sheet, Goertek had liabilities of CN¥43.6b due within 12 months, and liabilities of CN¥4.73b due beyond 12 months. Offsetting these obligations, it had cash of CN¥17.0b as well as receivables valued at CN¥14.7b due within 12 months. So its liabilities total CN¥16.6b more than the combination of its cash and short-term receivables.

Of course, Goertek has a titanic market capitalization of CN¥97.6b, so these liabilities are probably manageable. 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, Goertek boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Goertek turned things around in the last 12 months, delivering and EBIT of CN¥2.4b. 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 Goertek'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Goertek 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 year, Goertek actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although Goertek's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥21.5m. And it impressed us with free cash flow of CN¥2.9b, being 120% of its EBIT. So is Goertek's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Goertek that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.