Is ANT Precision Industry (GTSM:3646) Using Too Much Debt?

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.' 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 ANT Precision Industry Co., Ltd. (GTSM:3646) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for ANT Precision Industry

How Much Debt Does ANT Precision Industry Carry?

The image below, which you can click on for greater detail, shows that at September 2020 ANT Precision Industry had debt of NT$100.0m, up from NT$61.0m in one year. However, it does have NT$221.3m in cash offsetting this, leading to net cash of NT$121.3m.

How Healthy Is ANT Precision Industry's Balance Sheet?

We can see from the most recent balance sheet that ANT Precision Industry had liabilities of NT$225.2m falling due within a year, and liabilities of NT$15.0m due beyond that. On the other hand, it had cash of NT$221.3m and NT$146.9m worth of receivables due within a year. So it actually has NT$127.9m more liquid assets than total liabilities.

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

Better yet, ANT Precision Industry grew its EBIT by 117% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is ANT Precision Industry's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ANT Precision Industry 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. Looking at the most recent three years, ANT Precision Industry recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that ANT Precision Industry has net cash of NT$121.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 117% over the last year. So we don't think ANT Precision Industry's use of debt is risky. 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 instance, we've identified 2 warning signs for ANT Precision Industry that you should be aware of.

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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