Is Superior Plating Technology (GTSM:8431) 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.' 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 Superior Plating Technology Co., Ltd. (GTSM:8431) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

See our latest analysis for Superior Plating Technology

What Is Superior Plating Technology's Debt?

The image below, which you can click on for greater detail, shows that Superior Plating Technology had debt of NT$156.4m at the end of September 2020, a reduction from NT$183.9m over a year. But on the other hand it also has NT$163.3m in cash, leading to a NT$6.87m net cash position.

How Healthy Is Superior Plating Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Superior Plating Technology had liabilities of NT$407.7m due within 12 months and liabilities of NT$52.5m due beyond that. On the other hand, it had cash of NT$163.3m and NT$340.1m worth of receivables due within a year. So it can boast NT$43.1m more liquid assets than total liabilities.

This state of affairs indicates that Superior Plating Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$2.63b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Superior Plating Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Superior Plating Technology turned things around in the last 12 months, delivering and EBIT of NT$86m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Superior Plating Technology'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Superior Plating 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. Over the last year, Superior Plating Technology reported free cash flow worth 11% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Superior Plating Technology has net cash of NT$6.87m, as well as more liquid assets than liabilities. So we are not troubled with Superior Plating Technology's debt use. 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. We've identified 1 warning sign with Superior Plating Technology , and understanding them should be part of your investment process.

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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