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.' 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 Global SM Tech Limited (KOSDAQ:900070) does use debt in its business. But the real question is whether this debt is making the company risky.
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 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 examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for Global SM Tech
What Is Global SM Tech's Net Debt?
The chart below, which you can click on for greater detail, shows that Global SM Tech had ₩12.5b in debt in June 2020; about the same as the year before. But it also has ₩24.1b in cash to offset that, meaning it has ₩11.6b net cash.
How Healthy Is Global SM Tech's Balance Sheet?
We can see from the most recent balance sheet that Global SM Tech had liabilities of ₩24.9b falling due within a year, and liabilities of ₩14.3b due beyond that. On the other hand, it had cash of ₩24.1b and ₩40.4b worth of receivables due within a year. So it actually has ₩25.3b more liquid assets than total liabilities.
This surplus liquidity suggests that Global SM Tech's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Succinctly put, Global SM Tech boasts net cash, so it's fair to say it does not have a heavy debt load!
Importantly, Global SM Tech's EBIT fell a jaw-dropping 23% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Global SM Tech'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, a company can only pay off debt with cold hard cash, not accounting profits. While Global SM Tech 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 three years, Global SM Tech actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While it is always sensible to investigate a company's debt, in this case Global SM Tech has ₩11.6b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩6.1b, being 570% of its EBIT. So is Global SM Tech'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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Global SM Tech you should know about.
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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About KOSDAQ:A900070
Global SM Tech
Manufactures and sells small precision fasteners for electronic parts in South Korea.
Flawless balance sheet and slightly overvalued.
