Arlitech Electronic (GTSM:6432) Seems To Use Debt Rather Sparingly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Arlitech Electronic Corp. (GTSM:6432) does carry 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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Arlitech Electronic

How Much Debt Does Arlitech Electronic Carry?

The image below, which you can click on for greater detail, shows that Arlitech Electronic had debt of NT$83.2m at the end of December 2020, a reduction from NT$244.6m over a year. But on the other hand it also has NT$394.6m in cash, leading to a NT$311.4m net cash position.

A Look At Arlitech Electronic's Liabilities

We can see from the most recent balance sheet that Arlitech Electronic had liabilities of NT$327.3m falling due within a year, and liabilities of NT$48.2m due beyond that. On the other hand, it had cash of NT$394.6m and NT$389.1m worth of receivables due within a year. So it can boast NT$408.2m more liquid assets than total liabilities.

This surplus liquidity suggests that Arlitech Electronic's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Arlitech Electronic has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Arlitech Electronic grew its EBIT by 90% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Arlitech Electronic'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Arlitech Electronic 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 most recent three years, Arlitech Electronic recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Arlitech Electronic has NT$311.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 90% over the last year. So we don't think Arlitech Electronic's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Arlitech Electronic .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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