We Think Channel Well TechnologyLtd (GTSM:3078) Can Manage Its Debt With Ease

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Channel Well TechnologyLtd

What Is Channel Well TechnologyLtd's Debt?

As you can see below, at the end of September 2020, Channel Well TechnologyLtd had NT$690.0m of debt, up from NT$550.0m a year ago. Click the image for more detail. But it also has NT$3.41b in cash to offset that, meaning it has NT$2.72b net cash.

How Strong Is Channel Well TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Channel Well TechnologyLtd had liabilities of NT$3.31b due within a year, and liabilities of NT$345.5m falling due after that. Offsetting these obligations, it had cash of NT$3.41b as well as receivables valued at NT$2.42b due within 12 months. So it can boast NT$2.18b more liquid assets than total liabilities.

It's good to see that Channel Well TechnologyLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Channel Well TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Channel Well TechnologyLtd has boosted its EBIT by 100%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Channel Well TechnologyLtd will need earnings to service that debt. 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. Channel Well TechnologyLtd 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 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 it impressed us with its EBIT growth of 100% over the last year. So we don't think Channel Well TechnologyLtd's use of debt is risky. 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 2 warning signs for Channel Well TechnologyLtd you should be aware of.

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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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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