We Think ITEQ (TWSE:6213) Can Stay On Top Of Its Debt

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that ITEQ Corporation (TWSE:6213) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for ITEQ

What Is ITEQ's Net Debt?

As you can see below, at the end of December 2023, ITEQ had NT$5.27b of debt, up from NT$4.31b a year ago. Click the image for more detail. However, it does have NT$5.68b in cash offsetting this, leading to net cash of NT$417.3m.

How Strong Is ITEQ's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that ITEQ had liabilities of NT$10.5b due within 12 months and liabilities of NT$3.40b due beyond that. Offsetting these obligations, it had cash of NT$5.68b as well as receivables valued at NT$12.4b due within 12 months. So it actually has NT$4.16b more liquid assets than total liabilities.

This surplus suggests that ITEQ has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, ITEQ boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that ITEQ's load is not too heavy, because its EBIT was down 48% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 ITEQ 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 company can only pay off debt with cold hard cash, not accounting profits. While ITEQ 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. During the last three years, ITEQ produced sturdy free cash flow equating to 65% 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

While it is always sensible to investigate a company's debt, in this case ITEQ has NT$417.3m in net cash and a decent-looking balance sheet. So we don't have any problem with ITEQ's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for ITEQ you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.