We Think Axiomtek (GTSM:3088) Can Stay On Top Of Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Axiomtek Co., Ltd. (GTSM:3088) 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?

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.

See our latest analysis for Axiomtek

What Is Axiomtek's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Axiomtek had NT$665.2m of debt, an increase on NT$504.0m, over one year. But it also has NT$922.4m in cash to offset that, meaning it has NT$257.2m net cash.

A Look At Axiomtek's Liabilities

We can see from the most recent balance sheet that Axiomtek had liabilities of NT$1.19b falling due within a year, and liabilities of NT$582.5m due beyond that. Offsetting this, it had NT$922.4m in cash and NT$748.9m in receivables that were due within 12 months. So it has liabilities totalling NT$98.5m more than its cash and near-term receivables, combined.

Of course, Axiomtek has a market capitalization of NT$4.24b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Axiomtek boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Axiomtek if management cannot prevent a repeat of the 20% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Axiomtek's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Axiomtek 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. During the last three years, Axiomtek produced sturdy free cash flow equating to 75% 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.

Summing up

We could understand if investors are concerned about Axiomtek's liabilities, but we can be reassured by the fact it has has net cash of NT$257.2m. And it impressed us with free cash flow of NT$219m, being 75% of its EBIT. So we don't have any problem with Axiomtek's use of debt. 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. Be aware that Axiomtek is showing 4 warning signs in our investment analysis , and 1 of those is potentially serious...

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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