The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Super Dragon Technology Co., Ltd (TPE:9955) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Super Dragon Technology
What Is Super Dragon Technology's Debt?
As you can see below, at the end of December 2020, Super Dragon Technology had NT$1.22b of debt, up from NT$1.13b a year ago. Click the image for more detail. However, it does have NT$105.3m in cash offsetting this, leading to net debt of about NT$1.11b.
How Strong Is Super Dragon Technology's Balance Sheet?
The latest balance sheet data shows that Super Dragon Technology had liabilities of NT$835.2m due within a year, and liabilities of NT$457.5m falling due after that. Offsetting these obligations, it had cash of NT$105.3m as well as receivables valued at NT$14.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.17b.
This is a mountain of leverage relative to its market capitalization of NT$1.87b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Super Dragon Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year Super Dragon Technology wasn't profitable at an EBIT level, but managed to grow its revenue by 74%, to NT$3.0b. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
While we can certainly appreciate Super Dragon Technology's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at NT$130m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through NT$152m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Super Dragon Technology has 2 warning signs (and 1 which can't be ignored) 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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About TWSE:9955
Imperfect balance sheet very low.
