Is FineTek (GTSM:4549) 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.' 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 FineTek Co., Ltd. (GTSM:4549) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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 FineTek

What Is FineTek's Debt?

As you can see below, at the end of September 2020, FineTek had NT$302.0m of debt, up from NT$61.7m a year ago. Click the image for more detail. However, it does have NT$575.1m in cash offsetting this, leading to net cash of NT$273.1m.

How Strong Is FineTek's Balance Sheet?

According to the last reported balance sheet, FineTek had liabilities of NT$239.4m due within 12 months, and liabilities of NT$296.6m due beyond 12 months. On the other hand, it had cash of NT$575.1m and NT$164.7m worth of receivables due within a year. So it can boast NT$203.8m more liquid assets than total liabilities.

This surplus suggests that FineTek has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that FineTek has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that FineTek has seen its EBIT plunge 17% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since FineTek 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. FineTek 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. During the last three years, FineTek produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case FineTek has NT$273.1m in net cash and a decent-looking balance sheet. So we are not troubled with FineTek's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for FineTek (of which 1 is a bit unpleasant!) you should know about.

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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