Gemtek Technology (TPE:4906) Has A Pretty Healthy Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Gemtek Technology Co., Ltd. (TPE:4906) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, 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.

Check out our latest analysis for Gemtek Technology

What Is Gemtek Technology's Debt?

As you can see below, at the end of September 2020, Gemtek Technology had NT$2.22b of debt, up from NT$1.72b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$2.42b in cash, so it actually has NT$201.3m net cash.

How Healthy Is Gemtek Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gemtek Technology had liabilities of NT$10.3b due within 12 months and liabilities of NT$226.5m due beyond that. Offsetting these obligations, it had cash of NT$2.42b as well as receivables valued at NT$7.14b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$997.0m.

Since publicly traded Gemtek Technology shares are worth a total of NT$10.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Gemtek Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Gemtek Technology grew its EBIT by 141% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Gemtek Technology can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Gemtek Technology 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. Considering the last two years, Gemtek Technology actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Gemtek Technology has NT$201.3m in net cash. And it impressed us with its EBIT growth of 141% over the last year. So we are not troubled with Gemtek Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Gemtek Technology 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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