Here's Why Electric Power Technology (GTSM:4529) Can Afford Some Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Electric Power Technology Limited (GTSM:4529) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Electric Power Technology

How Much Debt Does Electric Power Technology Carry?

The image below, which you can click on for greater detail, shows that Electric Power Technology had debt of NT$261.6m at the end of September 2020, a reduction from NT$382.6m over a year. However, it does have NT$29.5m in cash offsetting this, leading to net debt of about NT$232.1m.

How Healthy Is Electric Power Technology's Balance Sheet?

The latest balance sheet data shows that Electric Power Technology had liabilities of NT$218.1m due within a year, and liabilities of NT$70.7m falling due after that. Offsetting these obligations, it had cash of NT$29.5m as well as receivables valued at NT$39.1m due within 12 months. So it has liabilities totalling NT$220.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Electric Power Technology is worth NT$917.6m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Electric Power Technology's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Electric Power Technology made a loss at the EBIT level, and saw its revenue drop to NT$5.2m, which is a fall of 37%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Electric Power Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable NT$116m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled NT$124m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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 4 warning signs for Electric Power Technology you should be aware of, and 3 of them are potentially serious.

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. 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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