Altek (TPE:3059) Seems To Use Debt Rather Sparingly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Altek Corporation (TPE:3059) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Altek

How Much Debt Does Altek Carry?

As you can see below, at the end of September 2020, Altek had NT$2.73b of debt, up from NT$2.39b a year ago. Click the image for more detail. But it also has NT$6.23b in cash to offset that, meaning it has NT$3.50b net cash.

A Look At Altek's Liabilities

The latest balance sheet data shows that Altek had liabilities of NT$4.63b due within a year, and liabilities of NT$791.0m falling due after that. On the other hand, it had cash of NT$6.23b and NT$1.11b worth of receivables due within a year. So it can boast NT$1.91b more liquid assets than total liabilities.

This excess liquidity suggests that Altek is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Altek 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, Altek turned things around in the last 12 months, delivering and EBIT of NT$13m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Altek 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. Altek 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. Happily for any shareholders, Altek actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Altek has net cash of NT$3.50b, as well as more liquid assets than liabilities. The cherry on top was that in converted 1,824% of that EBIT to free cash flow, bringing in NT$238m. So is Altek's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Altek , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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