Would RITEK (TPE:2349) Be Better Off With Less 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.' 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 RITEK Corporation (TPE:2349) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for RITEK

What Is RITEK's Net Debt?

The chart below, which you can click on for greater detail, shows that RITEK had NT$7.61b in debt in September 2020; about the same as the year before. On the flip side, it has NT$4.74b in cash leading to net debt of about NT$2.87b.

A Look At RITEK's Liabilities

According to the last reported balance sheet, RITEK had liabilities of NT$4.69b due within 12 months, and liabilities of NT$4.90b due beyond 12 months. Offsetting this, it had NT$4.74b in cash and NT$1.17b in receivables that were due within 12 months. So it has liabilities totalling NT$3.67b more than its cash and near-term receivables, combined.

This deficit isn't so bad because RITEK is worth NT$7.77b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since RITEK will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year RITEK had a loss before interest and tax, and actually shrunk its revenue by 18%, to NT$6.7b. That's not what we would hope to see.

Caveat Emptor

Not only did RITEK's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$719m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of NT$2.3b. In the meantime, we consider the stock very risky. For riskier companies like RITEK I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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