Is Powertip Technology (GTSM:6167) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Powertip Technology Corporation (GTSM:6167) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Powertip Technology

What Is Powertip Technology's Net Debt?

As you can see below, Powertip Technology had NT$145.0m of debt at September 2020, down from NT$180.0m a year prior. But on the other hand it also has NT$567.2m in cash, leading to a NT$422.2m net cash position.

A Look At Powertip Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Powertip Technology had liabilities of NT$259.7m due within 12 months and liabilities of NT$161.8m due beyond that. On the other hand, it had cash of NT$567.2m and NT$225.2m worth of receivables due within a year. So it actually has NT$370.9m more liquid assets than total liabilities.

This excess liquidity suggests that Powertip Technology is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Powertip Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Powertip Technology's load is not too heavy, because its EBIT was down 58% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Powertip Technology 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 company can only pay off debt with cold hard cash, not accounting profits. Powertip Technology 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 last three years, Powertip 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Powertip Technology has net cash of NT$422.2m, as well as more liquid assets than liabilities. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in NT$49m. So is Powertip Technology'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. To that end, you should be aware of the 2 warning signs we've spotted with Powertip Technology .

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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