Is ATE Energy International (GTSM:6179) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 ATE Energy International Co., Ltd. (GTSM:6179) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for ATE Energy International

What Is ATE Energy International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 ATE Energy International had NT$1.71b of debt, an increase on NT$969.6m, over one year. However, because it has a cash reserve of NT$1.38b, its net debt is less, at about NT$329.7m.

How Strong Is ATE Energy International's Balance Sheet?

The latest balance sheet data shows that ATE Energy International had liabilities of NT$1.94b due within a year, and liabilities of NT$645.4m falling due after that. Offsetting these obligations, it had cash of NT$1.38b as well as receivables valued at NT$2.02b due within 12 months. So it actually has NT$817.5m more liquid assets than total liabilities.

This surplus strongly suggests that ATE Energy International has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

ATE Energy International has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 12.3 times the size. So we're pretty relaxed about its super-conservative use of debt. Better yet, ATE Energy International grew its EBIT by 131% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since ATE Energy International 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, ATE Energy International saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Happily, ATE Energy International's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Zooming out, ATE Energy International seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. Be aware that ATE Energy International is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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