Here's Why Tai-Saw TechnologyLtd (GTSM:3221) Can Manage Its Debt Responsibly

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.' 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. As with many other companies Tai-Saw Technology Co.,Ltd. (GTSM:3221) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tai-Saw TechnologyLtd

What Is Tai-Saw TechnologyLtd's Debt?

As you can see below, at the end of September 2020, Tai-Saw TechnologyLtd had NT$532.9m of debt, up from NT$448.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$569.7m in cash, so it actually has NT$36.8m net cash.

A Look At Tai-Saw TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Tai-Saw TechnologyLtd had liabilities of NT$767.0m due within 12 months and liabilities of NT$132.1m due beyond that. Offsetting these obligations, it had cash of NT$569.7m as well as receivables valued at NT$437.0m due within 12 months. So it can boast NT$107.7m more liquid assets than total liabilities.

This surplus suggests that Tai-Saw TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tai-Saw TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Tai-Saw TechnologyLtd has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Tai-Saw 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, a company can only pay off debt with cold hard cash, not accounting profits. Tai-Saw 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 last three years, Tai-Saw TechnologyLtd recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tai-Saw TechnologyLtd has net cash of NT$36.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in NT$46m. So we are not troubled with Tai-Saw TechnologyLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Tai-Saw TechnologyLtd has 2 warning signs (and 1 which is significant) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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