AVY Precision Technology (GTSM:5392) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 AVY Precision Technology INC. (GTSM:5392) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for AVY Precision Technology

What Is AVY Precision Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 AVY Precision Technology had debt of NT$4.41b, up from NT$4.15b in one year. But it also has NT$4.95b in cash to offset that, meaning it has NT$543.8m net cash.

How Strong Is AVY Precision Technology's Balance Sheet?

According to the last reported balance sheet, AVY Precision Technology had liabilities of NT$6.58b due within 12 months, and liabilities of NT$1.68b due beyond 12 months. Offsetting these obligations, it had cash of NT$4.95b as well as receivables valued at NT$2.38b due within 12 months. So it has liabilities totalling NT$927.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because AVY Precision Technology is worth NT$3.96b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, AVY Precision Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for AVY Precision Technology if management cannot prevent a repeat of the 78% 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 it is AVY Precision Technology'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. While AVY Precision 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. Over the last three years, AVY Precision Technology actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although AVY Precision Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$543.8m. The cherry on top was that in converted 176% of that EBIT to free cash flow, bringing in NT$400m. So we don't have any problem with AVY Precision Technology's use of debt. 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. Be aware that AVY Precision Technology is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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