Eslite Spectrum (GTSM:2926) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies The Eslite Spectrum Corporation (GTSM:2926) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Eslite Spectrum

What Is Eslite Spectrum's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Eslite Spectrum had debt of NT$503.0m, up from none in one year. But it also has NT$1.14b in cash to offset that, meaning it has NT$640.4m net cash.

A Look At Eslite Spectrum's Liabilities

Zooming in on the latest balance sheet data, we can see that Eslite Spectrum had liabilities of NT$4.28b due within 12 months and liabilities of NT$9.08b due beyond that. Offsetting this, it had NT$1.14b in cash and NT$981.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$11.2b.

The deficiency here weighs heavily on the NT$3.51b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Eslite Spectrum would likely require a major re-capitalisation if it had to pay its creditors today. Given that Eslite Spectrum has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Shareholders should be aware that Eslite Spectrum's EBIT was down 81% last year. 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 you can't view debt in total isolation; since Eslite Spectrum will need earnings to service that debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. While Eslite Spectrum has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Eslite Spectrum actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Eslite Spectrum's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$640.4m. And it impressed us with free cash flow of NT$1.0b, being 313% of its EBIT. Despite its cash we think that Eslite Spectrum seems to struggle to handle its total liabilities, so we are wary of the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Eslite Spectrum (including 2 which don't sit too well with us) .

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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