Health Check: How Prudently Does Fu Ta Material Technology (GTSM:4402) Use 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. Importantly, Fu Ta Material Technology Co., Ltd. (GTSM:4402) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fu Ta Material Technology

What Is Fu Ta Material Technology's Net Debt?

As you can see below, at the end of September 2020, Fu Ta Material Technology had NT$249.8m of debt, up from NT$176.3m a year ago. Click the image for more detail. However, it also had NT$25.9m in cash, and so its net debt is NT$223.9m.

How Healthy Is Fu Ta Material Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fu Ta Material Technology had liabilities of NT$272.1m due within 12 months and liabilities of NT$39.3m due beyond that. Offsetting this, it had NT$25.9m in cash and NT$20.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$264.8m.

When you consider that this deficiency exceeds the company's NT$248.4m market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Fu Ta Material 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.

Over 12 months, Fu Ta Material Technology made a loss at the EBIT level, and saw its revenue drop to NT$139m, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

Not only did Fu Ta Material Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable NT$37m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NT$68m over the last twelve months. That means it's on the risky side of things. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Fu Ta Material Technology (of which 2 are a bit concerning!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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