Is Laser Tek TaiwanLtd (GTSM:6207) Using Too Much Debt?

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. We note that Laser Tek Taiwan Co.,Ltd (GTSM:6207) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Laser Tek TaiwanLtd

What Is Laser Tek TaiwanLtd's Debt?

The chart below, which you can click on for greater detail, shows that Laser Tek TaiwanLtd had NT$1.82b in debt in December 2020; about the same as the year before. However, because it has a cash reserve of NT$1.48b, its net debt is less, at about NT$334.1m.

A Look At Laser Tek TaiwanLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Laser Tek TaiwanLtd had liabilities of NT$1.78b due within 12 months and liabilities of NT$414.8m due beyond that. Offsetting this, it had NT$1.48b in cash and NT$510.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$203.3m.

Given Laser Tek TaiwanLtd has a market capitalization of NT$2.83b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Laser Tek TaiwanLtd's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. Pleasingly, Laser Tek TaiwanLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 130% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Laser Tek TaiwanLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Laser Tek TaiwanLtd recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Laser Tek TaiwanLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think Laser Tek TaiwanLtd is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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. We've identified 4 warning signs with Laser Tek TaiwanLtd (at least 2 which can't be ignored) , and understanding them should be part of your investment process.

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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