David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that INTAI Technology Corporation (GTSM:4163) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
What Is INTAI Technology's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 INTAI Technology had NT$707.7m of debt, an increase on NT$498.8m, over one year. But on the other hand it also has NT$858.1m in cash, leading to a NT$150.5m net cash position.
How Healthy Is INTAI Technology's Balance Sheet?
According to the last reported balance sheet, INTAI Technology had liabilities of NT$723.0m due within 12 months, and liabilities of NT$696.0m due beyond 12 months. Offsetting these obligations, it had cash of NT$858.1m as well as receivables valued at NT$203.5m due within 12 months. So it has liabilities totalling NT$357.4m more than its cash and near-term receivables, combined.
Of course, INTAI Technology has a market capitalization of NT$4.35b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, INTAI Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for INTAI Technology if management cannot prevent a repeat of the 25% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since INTAI Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. INTAI Technology 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. Over the most recent three years, INTAI Technology recorded free cash flow worth 64% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to look at a company's total liabilities, it is very reassuring that INTAI Technology has NT$150.5m in net cash. So we don't have any problem with INTAI Technology'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 1 warning sign we've spotted with INTAI Technology .
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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INTAI Technology Corporation offers a range of products for the automotive, aerospace, precision hardware, medical device, and electronic communication industries in Taiwan and internationally.
Excellent balance sheet and good value.
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