Alliance Material (GTSM:3595) Has A Rock Solid Balance Sheet

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. As with many other companies Alliance Material Co., Ltd. (GTSM:3595) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View our latest analysis for Alliance Material

How Much Debt Does Alliance Material Carry?

As you can see below, at the end of December 2020, Alliance Material had NT$49.0m of debt, up from NT$11.6m a year ago. Click the image for more detail. But it also has NT$203.7m in cash to offset that, meaning it has NT$154.7m net cash.

How Strong Is Alliance Material's Balance Sheet?

The latest balance sheet data shows that Alliance Material had liabilities of NT$179.2m due within a year, and liabilities of NT$883.0k falling due after that. Offsetting these obligations, it had cash of NT$203.7m as well as receivables valued at NT$140.9m due within 12 months. So it can boast NT$164.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Alliance Material could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Alliance Material has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Alliance Material grew its EBIT by 17% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Alliance Material 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. Alliance Material 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, Alliance Material actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Alliance Material has NT$154.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in NT$111m. So is Alliance Material's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Alliance Material you should know about.

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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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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