Tera Autotech (GTSM:6234) Has A Pretty Healthy Balance Sheet

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. As with many other companies Tera Autotech Corporation (GTSM:6234) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tera Autotech

What Is Tera Autotech's Debt?

As you can see below, at the end of December 2020, Tera Autotech had NT$1.04b of debt, up from NT$645.7m a year ago. Click the image for more detail. But it also has NT$1.80b in cash to offset that, meaning it has NT$761.3m net cash.

A Look At Tera Autotech's Liabilities

Zooming in on the latest balance sheet data, we can see that Tera Autotech had liabilities of NT$1.56b due within 12 months and liabilities of NT$37.1m due beyond that. Offsetting these obligations, it had cash of NT$1.80b as well as receivables valued at NT$363.7m due within 12 months. So it actually has NT$562.4m more liquid assets than total liabilities.

This excess liquidity suggests that Tera Autotech is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Tera Autotech boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Tera Autotech if management cannot prevent a repeat of the 35% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Tera Autotech's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Tera Autotech 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. Looking at the most recent three years, Tera Autotech recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tera Autotech has net cash of NT$761.3m, as well as more liquid assets than liabilities. So we don't have any problem with Tera Autotech's use of debt. 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. For example Tera Autotech has 3 warning signs (and 2 which shouldn't be ignored) we think 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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