East Tender Optoelectronics (GTSM:6588) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies East Tender Optoelectronics Corporation (GTSM:6588) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for East Tender Optoelectronics

How Much Debt Does East Tender Optoelectronics Carry?

The image below, which you can click on for greater detail, shows that at December 2020 East Tender Optoelectronics had debt of NT$123.9m, up from NT$112.0m in one year. However, its balance sheet shows it holds NT$488.8m in cash, so it actually has NT$364.9m net cash.

How Strong Is East Tender Optoelectronics' Balance Sheet?

We can see from the most recent balance sheet that East Tender Optoelectronics had liabilities of NT$82.0m falling due within a year, and liabilities of NT$105.2m due beyond that. Offsetting these obligations, it had cash of NT$488.8m as well as receivables valued at NT$76.3m due within 12 months. So it actually has NT$377.9m more liquid assets than total liabilities.

It's good to see that East Tender Optoelectronics has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that East Tender Optoelectronics has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, East Tender Optoelectronics grew its EBIT by 8.0% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is East Tender Optoelectronics's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. East Tender Optoelectronics 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. During the last three years, East Tender Optoelectronics produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that East Tender Optoelectronics has net cash of NT$364.9m, as well as more liquid assets than liabilities. So is East Tender Optoelectronics's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 4 warning signs for East Tender Optoelectronics you should be aware of, and 1 of them is a bit unpleasant.

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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