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.' 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. As with many other companies Singatron Enterprise Co., Ltd. (GTSM:6126) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Singatron Enterprise's Debt?
The image below, which you can click on for greater detail, shows that Singatron Enterprise had debt of NT$341.7m at the end of December 2020, a reduction from NT$429.9m over a year. However, it does have NT$796.3m in cash offsetting this, leading to net cash of NT$454.7m.
How Strong Is Singatron Enterprise's Balance Sheet?
According to the last reported balance sheet, Singatron Enterprise had liabilities of NT$1.63b due within 12 months, and liabilities of NT$472.1m due beyond 12 months. Offsetting these obligations, it had cash of NT$796.3m as well as receivables valued at NT$1.51b due within 12 months. So it can boast NT$200.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Singatron Enterprise could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Singatron Enterprise has more cash than debt is arguably a good indication that it can manage its debt safely.
Even more impressive was the fact that Singatron Enterprise grew its EBIT by 102% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Singatron Enterprise 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Singatron Enterprise 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, Singatron Enterprise produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Singatron Enterprise has NT$454.7m in net cash and a decent-looking balance sheet. And we liked the look of last year's 102% year-on-year EBIT growth. So we don't think Singatron Enterprise's use of debt is risky. 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. For instance, we've identified 1 warning sign for Singatron Enterprise that you should be aware of.
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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