We Think Data Image (GTSM:3168) Can Manage Its Debt With Ease

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.' 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. We note that Data Image Corporation (GTSM:3168) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Data Image

What Is Data Image's Debt?

As you can see below, Data Image had NT$86.4m of debt at December 2020, down from NT$126.3m a year prior. But it also has NT$377.5m in cash to offset that, meaning it has NT$291.0m net cash.

How Strong Is Data Image's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Data Image had liabilities of NT$993.9m due within 12 months and liabilities of NT$34.4m due beyond that. Offsetting these obligations, it had cash of NT$377.5m as well as receivables valued at NT$834.4m due within 12 months. So it can boast NT$183.6m more liquid assets than total liabilities.

This surplus suggests that Data Image has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Data Image has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Data Image grew its EBIT by 2.0% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Data Image will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the most recent three years, Data Image recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Data Image has net cash of NT$291.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$42m, being 69% of its EBIT. So we don't think Data Image's use of debt is risky. 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 Data Image is showing 2 warning signs in our investment analysis , you should know about...

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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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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