Does ADATA Technology (GTSM:3260) Have A Healthy 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. We note that ADATA Technology Co., Ltd. (GTSM:3260) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ADATA Technology

What Is ADATA Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that ADATA Technology had NT$12.6b of debt in September 2020, down from NT$14.8b, one year before. However, because it has a cash reserve of NT$2.81b, its net debt is less, at about NT$9.82b.

A Look At ADATA Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that ADATA Technology had liabilities of NT$10.3b due within 12 months and liabilities of NT$7.59b due beyond that. On the other hand, it had cash of NT$2.81b and NT$4.48b worth of receivables due within a year. So it has liabilities totalling NT$10.6b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of NT$17.5b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely ADATA Technology has a sky high EBITDA ratio of 5.4, implying high debt, but a strong interest coverage of 10.2. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, ADATA Technology made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$1.6b in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ADATA Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

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, ADATA Technology actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

When it comes to the balance sheet, the standout positive for ADATA Technology was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. In particular, net debt to EBITDA gives us cold feet. Looking at all this data makes us feel a little cautious about ADATA Technology's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. For instance, we've identified 1 warning sign for ADATA Technology that you should be aware of.

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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