Is Nova Technology (GTSM:6613) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Nova Technology Corp. (GTSM:6613) 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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Nova Technology

How Much Debt Does Nova Technology Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Nova Technology had debt of NT$180.0m, up from none in one year. However, it does have NT$1.54b in cash offsetting this, leading to net cash of NT$1.36b.

A Look At Nova Technology's Liabilities

According to the last reported balance sheet, Nova Technology had liabilities of NT$2.00b due within 12 months, and liabilities of NT$298.2m due beyond 12 months. On the other hand, it had cash of NT$1.54b and NT$2.29b worth of receivables due within a year. So it actually has NT$1.53b more liquid assets than total liabilities.

This surplus strongly suggests that Nova Technology has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Nova Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Nova Technology grew its EBIT by 5.6% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nova 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Nova Technology has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Nova Technology's free cash flow amounted to 39% of its EBIT, less 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 Nova Technology has net cash of NT$1.36b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 5.6% in the last twelve months. So we don't think Nova Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Nova Technology you should know about.

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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