Health Check: How Prudently Does Magnate Technology (GTSM:4541) Use Debt?

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.' 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 note that Magnate Technology Co., Ltd. (GTSM:4541) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Magnate Technology

What Is Magnate Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Magnate Technology had NT$1.92b of debt, an increase on NT$1.48b, over one year. However, because it has a cash reserve of NT$709.4m, its net debt is less, at about NT$1.21b.

How Healthy Is Magnate Technology's Balance Sheet?

The latest balance sheet data shows that Magnate Technology had liabilities of NT$672.2m due within a year, and liabilities of NT$1.81b falling due after that. On the other hand, it had cash of NT$709.4m and NT$187.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.58b.

Given this deficit is actually higher than the company's market capitalization of NT$1.46b, we think shareholders really should watch Magnate Technology's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Magnate Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Magnate Technology had a loss before interest and tax, and actually shrunk its revenue by 29%, to NT$1.1b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Magnate Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$82m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of NT$56m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be 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. For instance, we've identified 3 warning signs for Magnate Technology (1 is a bit concerning) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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