Does Prosperity Dielectrics (GTSM:6173) Have A Healthy Balance Sheet?

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.' 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 can see that Prosperity Dielectrics Co., Ltd. (GTSM:6173) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Prosperity Dielectrics

How Much Debt Does Prosperity Dielectrics Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Prosperity Dielectrics had NT$762.0m of debt, an increase on NT$120.0m, over one year. But on the other hand it also has NT$1.56b in cash, leading to a NT$799.1m net cash position.

A Look At Prosperity Dielectrics' Liabilities

According to the last reported balance sheet, Prosperity Dielectrics had liabilities of NT$1.57b due within 12 months, and liabilities of NT$1.03b due beyond 12 months. Offsetting this, it had NT$1.56b in cash and NT$1.12b in receivables that were due within 12 months. So it can boast NT$84.5m more liquid assets than total liabilities.

Having regard to Prosperity Dielectrics' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NT$10.6b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Prosperity Dielectrics has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Prosperity Dielectrics's load is not too heavy, because its EBIT was down 30% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is Prosperity Dielectrics'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Prosperity Dielectrics 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, Prosperity Dielectrics recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Prosperity Dielectrics has NT$799.1m in net cash and a decent-looking balance sheet. So we are not troubled with Prosperity Dielectrics's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Prosperity Dielectrics you should know about.

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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