Is Powertip Technology (GTSM:6167) 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 Powertip Technology Corporation (GTSM:6167) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Powertip Technology

What Is Powertip Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Powertip Technology had NT$129.7m of debt in December 2020, down from NT$180.0m, one year before. But it also has NT$587.3m in cash to offset that, meaning it has NT$457.6m net cash.

How Strong Is Powertip Technology's Balance Sheet?

We can see from the most recent balance sheet that Powertip Technology had liabilities of NT$285.2m falling due within a year, and liabilities of NT$161.3m due beyond that. Offsetting these obligations, it had cash of NT$587.3m as well as receivables valued at NT$219.6m due within 12 months. So it can boast NT$360.5m more liquid assets than total liabilities.

It's good to see that Powertip Technology has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble 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 87% 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 it is Powertip Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Powertip Technology has net cash of NT$457.6m, as well as more liquid assets than liabilities. The cherry on top was that in converted 131% of that EBIT to free cash flow, bringing in NT$292m. So we don't think Powertip Technology'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. For example - Powertip Technology has 3 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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