Is C.C.P. Contact Probes (GTSM:6217) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies C.C.P. Contact Probes Co., Ltd. (GTSM:6217) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for C.C.P. Contact Probes

How Much Debt Does C.C.P. Contact Probes Carry?

The image below, which you can click on for greater detail, shows that at September 2020 C.C.P. Contact Probes had debt of NT$141.2m, up from NT$10.0m in one year. But on the other hand it also has NT$372.3m in cash, leading to a NT$231.1m net cash position.

How Healthy Is C.C.P. Contact Probes's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that C.C.P. Contact Probes had liabilities of NT$811.7m due within 12 months and liabilities of NT$227.9m due beyond that. Offsetting these obligations, it had cash of NT$372.3m as well as receivables valued at NT$925.0m due within 12 months. So it can boast NT$257.6m more liquid assets than total liabilities.

This surplus suggests that C.C.P. Contact Probes has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that C.C.P. Contact Probes has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact C.C.P. Contact Probes's saving grace is its low debt levels, because its EBIT has tanked 33% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since C.C.P. Contact Probes 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 C.C.P. Contact Probes 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. Considering the last three years, C.C.P. Contact Probes actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that C.C.P. Contact Probes has net cash of NT$231.1m, as well as more liquid assets than liabilities. So we don't have any problem with C.C.P. Contact Probes's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 5 warning signs we've spotted with C.C.P. Contact Probes (including 1 which is is a bit unpleasant) .

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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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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