We Think Chroma ATE (TWSE:2360) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Chroma ATE Inc. (TWSE:2360) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Chroma ATE

How Much Debt Does Chroma ATE Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Chroma ATE had debt of NT$2.41b, up from NT$1.46b in one year. But on the other hand it also has NT$6.39b in cash, leading to a NT$3.98b net cash position.

How Strong Is Chroma ATE's Balance Sheet?

We can see from the most recent balance sheet that Chroma ATE had liabilities of NT$10.7b falling due within a year, and liabilities of NT$3.02b due beyond that. Offsetting this, it had NT$6.39b in cash and NT$5.62b in receivables that were due within 12 months. So its liabilities total NT$1.69b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Chroma ATE's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$162.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Chroma ATE also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Chroma ATE has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Chroma ATE 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Chroma ATE 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, Chroma ATE produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Chroma ATE's liabilities, but we can be reassured by the fact it has has net cash of NT$3.98b. And it impressed us with free cash flow of NT$3.6b, being 70% of its EBIT. So we don't have any problem with Chroma ATE's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Chroma ATE you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.