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Ample Electronic TechnologyLtd (GTSM:4760) Seems To Use Debt Quite Sensibly
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.' 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 Ample Electronic Technology Co.,Ltd. (GTSM:4760) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Ample Electronic TechnologyLtd
How Much Debt Does Ample Electronic TechnologyLtd Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Ample Electronic TechnologyLtd had debt of NT$355.2m, up from NT$231.9m in one year. However, because it has a cash reserve of NT$107.8m, its net debt is less, at about NT$247.4m.
How Healthy Is Ample Electronic TechnologyLtd's Balance Sheet?
The latest balance sheet data shows that Ample Electronic TechnologyLtd had liabilities of NT$362.4m due within a year, and liabilities of NT$141.6m falling due after that. Offsetting these obligations, it had cash of NT$107.8m as well as receivables valued at NT$434.0m due within 12 months. So it can boast NT$37.7m more liquid assets than total liabilities.
Having regard to Ample Electronic TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$2.16b company is struggling for cash, we still think it's worth monitoring its balance sheet.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Ample Electronic TechnologyLtd's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 27.3 times, makes us even more comfortable. Better yet, Ample Electronic TechnologyLtd grew its EBIT by 259% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Ample Electronic TechnologyLtd 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ample Electronic TechnologyLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
Our View
The good news is that Ample Electronic TechnologyLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Ample Electronic TechnologyLtd can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Ample Electronic TechnologyLtd (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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About TPEX:4760
Ample Electronic TechnologyLtd
Engages in the research, development, design, manufacturing, and sale of thick-film conductive materials in Taiwan.
Solid track record with adequate balance sheet.