These 4 Measures Indicate That Globaltec Formation Berhad (KLSE:GLOTEC) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Globaltec Formation Berhad (KLSE:GLOTEC) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Globaltec Formation Berhad

How Much Debt Does Globaltec Formation Berhad Carry?

The image below, which you can click on for greater detail, shows that Globaltec Formation Berhad had debt of RM15.6m at the end of December 2020, a reduction from RM23.2m over a year. But it also has RM89.2m in cash to offset that, meaning it has RM73.6m net cash.

How Healthy Is Globaltec Formation Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Globaltec Formation Berhad had liabilities of RM76.6m due within 12 months and liabilities of RM14.1m due beyond that. On the other hand, it had cash of RM89.2m and RM33.4m worth of receivables due within a year. So it can boast RM31.9m more liquid assets than total liabilities.

This surplus suggests that Globaltec Formation Berhad is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Globaltec Formation Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Globaltec Formation Berhad turned things around in the last 12 months, delivering and EBIT of RM34m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Globaltec Formation Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Globaltec Formation Berhad 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 year, Globaltec Formation Berhad's free cash flow amounted to 29% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Globaltec Formation Berhad has RM73.6m in net cash and a decent-looking balance sheet. So is Globaltec Formation Berhad's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Globaltec Formation Berhad 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.

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