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. Importantly, Giga-Byte Technology Co., Ltd. (TPE:2376) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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 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, 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Giga-Byte Technology’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Giga-Byte Technology had NT$547.7m of debt, an increase on NT$299.8m, over one year. However, its balance sheet shows it holds NT$17.4b in cash, so it actually has NT$16.9b net cash.
How Healthy Is Giga-Byte Technology’s Balance Sheet?
We can see from the most recent balance sheet that Giga-Byte Technology had liabilities of NT$21.0b falling due within a year, and liabilities of NT$1.03b due beyond that. On the other hand, it had cash of NT$17.4b and NT$7.95b worth of receivables due within a year. So it can boast NT$3.34b more liquid assets than total liabilities.
This short term liquidity is a sign that Giga-Byte Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Giga-Byte Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Giga-Byte Technology grew its EBIT by 190% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Giga-Byte Technology’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Giga-Byte 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. Over the last three years, Giga-Byte Technology recorded free cash flow worth a fulsome 95% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company’s debt, in this case Giga-Byte Technology has NT$16.9b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in NT$7.3b. So we don’t think Giga-Byte Technology’s use of debt is risky. 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. For instance, we’ve identified 1 warning sign for Giga-Byte Technology that you should be aware of.
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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