Top Union Electronics (GTSM:6266) Seems To Use Debt Quite Sensibly

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.' 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 Top Union Electronics Corp. (GTSM:6266) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Top Union Electronics

What Is Top Union Electronics's Net Debt?

As you can see below, at the end of September 2020, Top Union Electronics had NT$327.0m of debt, up from NT$279.0m a year ago. Click the image for more detail. But it also has NT$434.4m in cash to offset that, meaning it has NT$107.4m net cash.

How Strong Is Top Union Electronics's Balance Sheet?

The latest balance sheet data shows that Top Union Electronics had liabilities of NT$694.8m due within a year, and liabilities of NT$53.7m falling due after that. Offsetting this, it had NT$434.4m in cash and NT$367.8m in receivables that were due within 12 months. So it actually has NT$53.6m more liquid assets than total liabilities.

This surplus suggests that Top Union Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Top Union Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Top Union Electronics saw its EBIT decline by 3.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is Top Union Electronics'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Top Union Electronics 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. Over the last three years, Top Union Electronics reported free cash flow worth 16% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Top Union Electronics has net cash of NT$107.4m, as well as more liquid assets than liabilities. So we are not troubled with Top Union Electronics's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Top Union Electronics is showing 2 warning signs in our investment analysis , you should know about...

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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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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