ELTA TechnologyLtd (GTSM:8487) Has A Somewhat Strained Balance Sheet

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.' 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 ELTA Technology Co.,Ltd. (GTSM:8487) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for ELTA TechnologyLtd

What Is ELTA TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 ELTA TechnologyLtd had NT$60.0m of debt, an increase on NT$20.0m, over one year. However, its balance sheet shows it holds NT$245.3m in cash, so it actually has NT$185.3m net cash.

How Strong Is ELTA TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ELTA TechnologyLtd had liabilities of NT$363.5m due within 12 months and liabilities of NT$59.6m due beyond that. On the other hand, it had cash of NT$245.3m and NT$87.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$90.2m.

ELTA TechnologyLtd has a market capitalization of NT$335.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, ELTA TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, ELTA TechnologyLtd's EBIT fell a jaw-dropping 76% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is ELTA TechnologyLtd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ELTA TechnologyLtd 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. During the last two years, ELTA TechnologyLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While ELTA TechnologyLtd does have more liabilities than liquid assets, it also has net cash of NT$185.3m. Despite its cash we think that ELTA TechnologyLtd seems to struggle to grow its EBIT, so we are wary of the stock. 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. Be aware that ELTA TechnologyLtd is showing 5 warning signs in our investment analysis , and 1 of those can't be ignored...

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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