Ligitek Electronics (GTSM:8111) Has A Rock Solid Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We note that Ligitek Electronics Co., Ltd. (GTSM:8111) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ligitek Electronics

What Is Ligitek Electronics's Net Debt?

As you can see below, at the end of September 2020, Ligitek Electronics had NT$469.6m of debt, up from NT$395.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$531.0m in cash, so it actually has NT$61.3m net cash.

How Strong Is Ligitek Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ligitek Electronics had liabilities of NT$626.0m due within 12 months and liabilities of NT$114.8m due beyond that. Offsetting these obligations, it had cash of NT$531.0m as well as receivables valued at NT$311.0m due within 12 months. So it actually has NT$101.2m more liquid assets than total liabilities.

This surplus suggests that Ligitek Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ligitek Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Ligitek Electronics grew its EBIT by 268% 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 it is Ligitek Electronics's earnings that will influence how the balance sheet holds up in the future. 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. Ligitek Electronics 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. Happily for any shareholders, Ligitek Electronics actually produced more free cash flow than EBIT over the last two 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 we empathize with investors who find debt concerning, you should keep in mind that Ligitek Electronics has net cash of NT$61.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$112m, being 158% of its EBIT. So is Ligitek Electronics's debt a risk? It doesn't seem so to us. 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. We've identified 2 warning signs with Ligitek Electronics , and understanding them should be part of your investment process.

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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