Tai-Saw TechnologyLtd (GTSM:3221) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Tai-Saw Technology Co.,Ltd. (GTSM:3221) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tai-Saw TechnologyLtd

What Is Tai-Saw TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Tai-Saw TechnologyLtd had NT$532.9m of debt, an increase on NT$448.3m, over one year. But it also has NT$569.7m in cash to offset that, meaning it 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. On the other hand, it had cash of NT$569.7m and NT$437.0m worth of receivables due within a year. So it actually has 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. Succinctly put, Tai-Saw TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Tai-Saw TechnologyLtd's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tai-Saw 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 positions it well to pay down debt if desirable to do so.

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. And it impressed us with free cash flow of NT$46m, being 83% of its EBIT. 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. To that end, you should learn about the 2 warning signs we've spotted with Tai-Saw TechnologyLtd (including 1 which is makes us a bit uncomfortable) .

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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