These 4 Measures Indicate That P-Duke TechnologyLtd (GTSM:8109) Is Using Debt Reasonably Well

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.' 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. Importantly, P-Duke Technology Co.,Ltd. (GTSM:8109) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for P-Duke TechnologyLtd

What Is P-Duke TechnologyLtd's Net Debt?

As you can see below, P-Duke TechnologyLtd had NT$1.18b of debt at September 2020, down from NT$1.38b a year prior. However, it does have NT$1.48b in cash offsetting this, leading to net cash of NT$303.7m.

How Strong Is P-Duke TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that P-Duke TechnologyLtd had liabilities of NT$1.21b due within 12 months and liabilities of NT$297.9m due beyond that. Offsetting these obligations, it had cash of NT$1.48b as well as receivables valued at NT$111.4m due within 12 months. So it can boast NT$82.1m more liquid assets than total liabilities.

Having regard to P-Duke TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$4.90b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that P-Duke TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that P-Duke TechnologyLtd has seen its EBIT plunge 14% 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 ultimately the future profitability of the business will decide if P-Duke TechnologyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. P-Duke TechnologyLtd 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, P-Duke TechnologyLtd recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case P-Duke TechnologyLtd has NT$303.7m in net cash and a decent-looking balance sheet. So we don't have any problem with P-Duke TechnologyLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with P-Duke TechnologyLtd .

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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