Avalue Technology (GTSM:3479) Seems To Use Debt Quite Sensibly

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. Importantly, Avalue Technology Inc. (GTSM:3479) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Avalue Technology

What Is Avalue Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Avalue Technology had NT$257.3m of debt in September 2020, down from NT$480.3m, one year before. But on the other hand it also has NT$833.2m in cash, leading to a NT$576.0m net cash position.

How Healthy Is Avalue Technology's Balance Sheet?

According to the last reported balance sheet, Avalue Technology had liabilities of NT$951.9m due within 12 months, and liabilities of NT$196.6m due beyond 12 months. Offsetting these obligations, it had cash of NT$833.2m as well as receivables valued at NT$638.9m due within 12 months. So it can boast NT$323.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Avalue Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Avalue Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Avalue Technology's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Avalue Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Avalue Technology 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, Avalue Technology generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Avalue Technology has NT$576.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in NT$220m. So we are not troubled with Avalue Technology's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Avalue Technology , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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