Is Winstek Semiconductor (GTSM:3265) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Winstek Semiconductor Co., Ltd. (GTSM:3265) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Winstek Semiconductor

What Is Winstek Semiconductor's Debt?

You can click the graphic below for the historical numbers, but it shows that Winstek Semiconductor had NT$430.5m of debt in December 2020, down from NT$690.0m, one year before. However, it does have NT$3.05b in cash offsetting this, leading to net cash of NT$2.62b.

How Healthy Is Winstek Semiconductor's Balance Sheet?

The latest balance sheet data shows that Winstek Semiconductor had liabilities of NT$639.7m due within a year, and liabilities of NT$323.9m falling due after that. On the other hand, it had cash of NT$3.05b and NT$669.4m worth of receivables due within a year. So it can boast NT$2.75b more liquid assets than total liabilities.

This luscious liquidity implies that Winstek Semiconductor's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Winstek Semiconductor boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Winstek Semiconductor's load is not too heavy, because its EBIT was down 65% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Winstek Semiconductor 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Winstek Semiconductor 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, Winstek Semiconductor 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

While it is always sensible to investigate a company's debt, in this case Winstek Semiconductor has NT$2.62b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$725m, being 159% of its EBIT. So we don't think Winstek Semiconductor'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. To that end, you should be aware of the 2 warning signs we've spotted with Winstek Semiconductor .

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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