These 4 Measures Indicate That Advancetek EnterpriseLtd (TPE:1442) Is Using Debt Extensively

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Advancetek Enterprise Co.,Ltd. (TPE:1442) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Advancetek EnterpriseLtd

What Is Advancetek EnterpriseLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Advancetek EnterpriseLtd had NT$6.61b of debt, an increase on NT$5.62b, over one year. However, it also had NT$175.3m in cash, and so its net debt is NT$6.44b.

How Strong Is Advancetek EnterpriseLtd's Balance Sheet?

The latest balance sheet data shows that Advancetek EnterpriseLtd had liabilities of NT$3.33b due within a year, and liabilities of NT$4.20b falling due after that. Offsetting this, it had NT$175.3m in cash and NT$87.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.26b.

When you consider that this deficiency exceeds the company's NT$6.35b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Advancetek EnterpriseLtd has a rather high debt to EBITDA ratio of 74.8 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.0 times, suggesting it can responsibly service its obligations. One redeeming factor for Advancetek EnterpriseLtd is that it turned last year's EBIT loss into a gain of NT$80m, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Advancetek EnterpriseLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Advancetek EnterpriseLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Advancetek EnterpriseLtd's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Overall, it seems to us that Advancetek EnterpriseLtd's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 5 warning signs with Advancetek EnterpriseLtd (at least 2 which are significant) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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