Is Hengs Technology (GTSM:4582) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Hengs Technology Co., Ltd. (GTSM:4582) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Hengs Technology

How Much Debt Does Hengs Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Hengs Technology had NT$400.8m of debt in December 2020, down from NT$475.8m, one year before. However, it does have NT$391.4m in cash offsetting this, leading to net debt of about NT$9.33m.

How Healthy Is Hengs Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hengs Technology had liabilities of NT$980.4m due within 12 months and liabilities of NT$435.8m due beyond that. Offsetting these obligations, it had cash of NT$391.4m as well as receivables valued at NT$485.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$539.4m.

Of course, Hengs Technology has a market capitalization of NT$3.24b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Hengs Technology has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With debt at a measly 0.032 times EBITDA and EBIT covering interest a whopping 21.6 times, it's clear that Hengs Technology is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Better yet, Hengs Technology grew its EBIT by 315% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hengs Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last two years, Hengs Technology's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Hengs Technology's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Hengs Technology seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. For instance, we've identified 4 warning signs for Hengs Technology that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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