Does Cherng Tay Technology (GTSM:4767) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Cherng Tay Technology Co., Ltd. (GTSM:4767) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Cherng Tay Technology

What Is Cherng Tay Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Cherng Tay Technology had NT$185.5m of debt, an increase on NT$155.1m, over one year. However, it does have NT$425.0m in cash offsetting this, leading to net cash of NT$239.5m.

How Healthy Is Cherng Tay Technology's Balance Sheet?

According to the last reported balance sheet, Cherng Tay Technology had liabilities of NT$287.1m due within 12 months, and liabilities of NT$272.7m due beyond 12 months. Offsetting this, it had NT$425.0m in cash and NT$290.3m in receivables that were due within 12 months. So it actually has NT$155.5m more liquid assets than total liabilities.

This excess liquidity suggests that Cherng Tay Technology is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Cherng Tay Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Cherng Tay Technology has boosted its EBIT by 54%, thus reducing the spectre of future debt repayments. 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 Cherng Tay 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Cherng Tay 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. Looking at the most recent three years, Cherng Tay Technology recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Cherng Tay Technology has NT$239.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 54% year-on-year EBIT growth. So is Cherng Tay Technology'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 2 warning signs with Cherng Tay Technology , and understanding them should be part of your investment process.

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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