These 4 Measures Indicate That UltraChip (GTSM:3141) Is Using Debt Reasonably Well

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.' 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 can see that UltraChip Inc. (GTSM:3141) does use debt in its business. But is this debt a concern to shareholders?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 UltraChip

How Much Debt Does UltraChip Carry?

The image below, which you can click on for greater detail, shows that at September 2020 UltraChip had debt of NT$103.3m, up from none in one year. But on the other hand it also has NT$529.4m in cash, leading to a NT$426.0m net cash position.

A Look At UltraChip's Liabilities

The latest balance sheet data shows that UltraChip had liabilities of NT$330.3m due within a year, and liabilities of NT$51.5m falling due after that. On the other hand, it had cash of NT$529.4m and NT$221.6m worth of receivables due within a year. So it actually has NT$369.3m more liquid assets than total liabilities.

This short term liquidity is a sign that UltraChip could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, UltraChip boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that UltraChip has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is UltraChip'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, a company can only pay off debt with cold hard cash, not accounting profits. UltraChip 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 three years, UltraChip produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that UltraChip has net cash of NT$426.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$127m, being 74% of its EBIT. So we don't think UltraChip's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for UltraChip (1 can't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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