Is Data Image (GTSM:3168) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Data Image Corporation (GTSM:3168) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Data Image

How Much Debt Does Data Image Carry?

As you can see below, Data Image had NT$83.8m of debt at June 2020, down from NT$151.9m a year prior. However, its balance sheet shows it holds NT$463.3m in cash, so it actually has NT$379.5m net cash.

How Healthy Is Data Image's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Data Image had liabilities of NT$719.1m due within 12 months and liabilities of NT$39.0m due beyond that. On the other hand, it had cash of NT$463.3m and NT$557.8m worth of receivables due within a year. So it actually has NT$263.0m more liquid assets than total liabilities.

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

But the other side of the story is that Data Image saw its EBIT decline by 3.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Data Image 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Data Image 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, Data Image produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case Data Image has NT$379.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$189m, being 73% of its EBIT. So is Data Image's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Data Image is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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