Is Solteam Electronics (GTSM:3484) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Solteam Electronics Co., Ltd. (GTSM:3484) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Solteam Electronics

What Is Solteam Electronics's Debt?

As you can see below, at the end of September 2020, Solteam Electronics had NT$711.7m of debt, up from NT$676.0m a year ago. Click the image for more detail. But on the other hand it also has NT$1.00b in cash, leading to a NT$290.6m net cash position.

How Healthy Is Solteam Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Solteam Electronics had liabilities of NT$1.76b due within 12 months and liabilities of NT$367.3m due beyond that. Offsetting this, it had NT$1.00b in cash and NT$921.5m in receivables that were due within 12 months. So it has liabilities totalling NT$204.9m more than its cash and near-term receivables, combined.

Of course, Solteam Electronics has a market capitalization of NT$4.76b, 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. While it does have liabilities worth noting, Solteam Electronics also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Solteam Electronics has boosted its EBIT by 86%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Solteam Electronics'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Solteam Electronics 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. Happily for any shareholders, Solteam Electronics actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Solteam Electronics has NT$290.6m in net cash. And it impressed us with free cash flow of NT$463m, being 101% of its EBIT. So is Solteam Electronics's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Solteam Electronics (including 1 which shouldn't be ignored) .

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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