Is C.C.P. Contact Probes (GTSM:6217) 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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that C.C.P. Contact Probes Co., Ltd. (GTSM:6217) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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

What Is C.C.P. Contact Probes's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 C.C.P. Contact Probes had NT$141.2m of debt, an increase on NT$10.0m, over one year. However, its balance sheet shows it holds NT$333.7m in cash, so it actually has NT$192.5m net cash.

How Strong Is C.C.P. Contact Probes' Balance Sheet?

The latest balance sheet data shows that C.C.P. Contact Probes had liabilities of NT$811.7m due within a year, and liabilities of NT$227.9m falling due after that. On the other hand, it had cash of NT$333.7m and NT$950.8m worth of receivables due within a year. So it actually has NT$245.0m more liquid assets than total liabilities.

This short term liquidity is a sign that C.C.P. Contact Probes could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, C.C.P. Contact Probes boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact C.C.P. Contact Probes's saving grace is its low debt levels, because its EBIT has tanked 35% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is C.C.P. Contact Probes's earnings that will influence how the balance sheet holds up in the future. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. C.C.P. Contact Probes 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. Over the last three years, C.C.P. Contact Probes saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case C.C.P. Contact Probes has NT$192.5m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about C.C.P. Contact Probes's balance sheet. 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. For example C.C.P. Contact Probes has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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