Is Litemax Electronics (GTSM:4995) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Litemax Electronics Inc. (GTSM:4995) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Litemax Electronics

How Much Debt Does Litemax Electronics Carry?

As you can see below, Litemax Electronics had NT$157.5m of debt at December 2020, down from NT$171.5m a year prior. But it also has NT$293.3m in cash to offset that, meaning it has NT$135.8m net cash.

How Healthy Is Litemax Electronics' Balance Sheet?

According to the last reported balance sheet, Litemax Electronics had liabilities of NT$258.4m due within 12 months, and liabilities of NT$152.3m due beyond 12 months. Offsetting these obligations, it had cash of NT$293.3m as well as receivables valued at NT$146.4m due within 12 months. So it can boast NT$29.0m more liquid assets than total liabilities.

This state of affairs indicates that Litemax Electronics' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$1.51b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Litemax Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Litemax Electronics if management cannot prevent a repeat of the 64% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Litemax Electronics 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. Litemax Electronics 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. Happily for any shareholders, Litemax Electronics actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Litemax Electronics has net cash of NT$135.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in NT$197m. So we are not troubled with Litemax Electronics's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Litemax Electronics , and understanding them should be part of your investment process.

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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