AIC (GTSM:3693) 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.' 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 AIC Inc. (GTSM:3693) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for AIC

How Much Debt Does AIC Carry?

You can click the graphic below for the historical numbers, but it shows that AIC had NT$345.3m of debt in September 2020, down from NT$370.0m, one year before. However, it does have NT$473.7m in cash offsetting this, leading to net cash of NT$128.4m.

A Look At AIC's Liabilities

The latest balance sheet data shows that AIC had liabilities of NT$1.16b due within a year, and liabilities of NT$125.6m falling due after that. On the other hand, it had cash of NT$473.7m and NT$556.1m worth of receivables due within a year. So it has liabilities totalling NT$253.9m more than its cash and near-term receivables, combined.

Given AIC has a market capitalization of NT$1.64b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, AIC also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although AIC made a loss at the EBIT level, last year, it was also good to see that it generated NT$165m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is AIC's earnings that will influence how the balance sheet holds up in the future. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While AIC 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. Over the last year, AIC recorded free cash flow worth a fulsome 90% 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 AIC does have more liabilities than liquid assets, it also has net cash of NT$128.4m. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in NT$149m. So is AIC's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 3 warning signs for AIC (1 is a bit unpleasant!) that you should be aware of before investing here.

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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