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. We note that Information Technology Total Services Co., Ltd (GTSM:6697) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Information Technology Total Services Carry?
You can click the graphic below for the historical numbers, but it shows that Information Technology Total Services had NT$80.0m of debt in September 2020, down from NT$236.9m, one year before. But on the other hand it also has NT$81.9m in cash, leading to a NT$1.94m net cash position.
How Healthy Is Information Technology Total Services's Balance Sheet?
We can see from the most recent balance sheet that Information Technology Total Services had liabilities of NT$218.2m falling due within a year, and liabilities of NT$95.6m due beyond that. Offsetting this, it had NT$81.9m in cash and NT$398.4m in receivables that were due within 12 months. So it actually has NT$166.7m more liquid assets than total liabilities.
This excess liquidity suggests that Information Technology Total Services 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. Succinctly put, Information Technology Total Services boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Information Technology Total Services grew its EBIT by 6.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Information Technology Total Services'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 company can only pay off debt with cold hard cash, not accounting profits. Information Technology Total Services 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, Information Technology Total Services actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to investigate a company's debt, in this case Information Technology Total Services has NT$1.94m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 127% of that EBIT to free cash flow, bringing in NT$110m. So is Information Technology Total Services's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 3 warning signs for Information Technology Total Services 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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