Health Check: How Prudently Does United Alloy-Tech (GTSM:3162) 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.' 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. We note that United Alloy-Tech Company (GTSM:3162) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for United Alloy-Tech

How Much Debt Does United Alloy-Tech Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 United Alloy-Tech had NT$169.8m of debt, an increase on NT$101.4m, over one year. However, it does have NT$230.6m in cash offsetting this, leading to net cash of NT$60.8m.

How Strong Is United Alloy-Tech's Balance Sheet?

The latest balance sheet data shows that United Alloy-Tech had liabilities of NT$536.8m due within a year, and liabilities of NT$177.8m falling due after that. Offsetting these obligations, it had cash of NT$230.6m as well as receivables valued at NT$182.6m due within 12 months. So its liabilities total NT$301.3m more than the combination of its cash and short-term receivables.

Given United Alloy-Tech has a market capitalization of NT$2.18b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, United Alloy-Tech also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since United Alloy-Tech 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.

Over 12 months, United Alloy-Tech saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

So How Risky Is United Alloy-Tech?

While United Alloy-Tech lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow NT$46m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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. For example United Alloy-Tech has 2 warning signs (and 1 which is significant) we think you should know about.

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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