Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that CTCI Advanced Systems Inc. (GTSM:5209) does use debt in its business. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is CTCI Advanced Systems's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2020 CTCI Advanced Systems had NT$293.0m of debt, an increase on none, over one year. However, it does have NT$266.1m in cash offsetting this, leading to net debt of about NT$26.9m.
A Look At CTCI Advanced Systems's Liabilities
According to the last reported balance sheet, CTCI Advanced Systems had liabilities of NT$1.27b due within 12 months, and liabilities of NT$71.6m due beyond 12 months. On the other hand, it had cash of NT$266.1m and NT$880.5m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$195.4m.
Since publicly traded CTCI Advanced Systems shares are worth a total of NT$1.61b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
CTCI Advanced Systems has a low debt to EBITDA ratio of only 0.39. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. It is just as well that CTCI Advanced Systems's load is not too heavy, because its EBIT was down 45% 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 CTCI Advanced Systems'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, CTCI Advanced Systems produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Based on what we've seen CTCI Advanced Systems is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think CTCI Advanced Systems is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with CTCI Advanced Systems (including 1 which is can't be ignored) .
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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