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. Importantly, Howteh Technology Co., Ltd. (GTSM:3114) does carry debt. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company’s use of debt, we first look at cash and debt together.
View our latest analysis for Howteh Technology
What Is Howteh Technology’s Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Howteh Technology had NT$801.9m of debt, an increase on NT$620.0m, over one year. However, it also had NT$649.2m in cash, and so its net debt is NT$152.7m.
A Look At Howteh Technology’s Liabilities
Zooming in on the latest balance sheet data, we can see that Howteh Technology had liabilities of NT$1.43b due within 12 months and liabilities of NT$5.65m due beyond that. Offsetting this, it had NT$649.2m in cash and NT$1.13b in receivables that were due within 12 months. So it can boast NT$346.1m more liquid assets than total liabilities.
This surplus suggests that Howteh Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Howteh Technology has a low debt to EBITDA ratio of only 0.81. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it’s fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. The good news is that Howteh Technology has increased its EBIT by 5.1% over twelve months, which should ease any concerns about debt repayment. 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 Howteh Technology will need earnings to service that debt. So if you’re keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Howteh Technology barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.
Our View
The good news is that Howteh Technology’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Howteh Technology can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it’s worth keeping an eye on this one. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Case in point: We’ve spotted 3 warning signs for Howteh Technology 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.
If you spot an error that warrants correction, please contact the editor at [email protected]. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
