Channel Well TechnologyLtd (GTSM:3078) Could Easily Take On More Debt

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. As with many other companies Channel Well Technology Co.,Ltd. (GTSM:3078) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Channel Well TechnologyLtd

How Much Debt Does Channel Well TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Channel Well TechnologyLtd had NT$690.0m of debt, an increase on NT$550.0m, over one year. However, it does have NT$3.41b in cash offsetting this, leading to net cash of NT$2.72b.

A Look At Channel Well TechnologyLtd's Liabilities

According to the last reported balance sheet, Channel Well TechnologyLtd had liabilities of NT$3.31b due within 12 months, and liabilities of NT$345.5m due beyond 12 months. Offsetting this, it had NT$3.41b in cash and NT$2.42b in receivables that were due within 12 months. So it actually has NT$2.18b more liquid assets than total liabilities.

This surplus suggests that Channel Well TechnologyLtd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Channel Well TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Channel Well TechnologyLtd grew its EBIT by 100% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Channel Well TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Channel Well TechnologyLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Channel Well TechnologyLtd recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Channel Well TechnologyLtd has net cash of NT$2.72b, as well as more liquid assets than liabilities. And we liked the look of last year's 100% year-on-year EBIT growth. So we don't think Channel Well TechnologyLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Channel Well TechnologyLtd is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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