Allied Circuit (GTSM:8155) 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.' 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 Allied Circuit Co., Ltd. (GTSM:8155) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Allied Circuit

What Is Allied Circuit's Net Debt?

As you can see below, at the end of September 2020, Allied Circuit had NT$160.1m of debt, up from NT$124.2m a year ago. Click the image for more detail. However, it does have NT$839.3m in cash offsetting this, leading to net cash of NT$679.2m.

How Strong Is Allied Circuit's Balance Sheet?

According to the last reported balance sheet, Allied Circuit had liabilities of NT$1.02b due within 12 months, and liabilities of NT$3.63m due beyond 12 months. Offsetting this, it had NT$839.3m in cash and NT$783.9m in receivables that were due within 12 months. So it can boast NT$596.7m more liquid assets than total liabilities.

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

Better yet, Allied Circuit grew its EBIT by 223% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Allied Circuit's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Allied Circuit 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, Allied Circuit generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Allied Circuit has net cash of NT$679.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$517m, being 84% of its EBIT. So is Allied Circuit's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Allied Circuit that you should be aware of.

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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