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 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. We can see that Newmax Technology Co., Ltd. (GTSM:3630) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Newmax Technology’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Newmax Technology had NT$1.14b of debt, an increase on NT$511.4m, over one year. However, it does have NT$2.64b in cash offsetting this, leading to net cash of NT$1.50b.
How Healthy Is Newmax Technology’s Balance Sheet?
We can see from the most recent balance sheet that Newmax Technology had liabilities of NT$1.60b falling due within a year, and liabilities of NT$1.08b due beyond that. On the other hand, it had cash of NT$2.64b and NT$868.1m worth of receivables due within a year. So it actually has NT$830.2m more liquid assets than total liabilities.
This surplus suggests that Newmax Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Newmax Technology boasts net cash, so it’s fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Newmax Technology’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Newmax Technology made a loss at the EBIT level, and saw its revenue drop to NT$2.7b, which is a fall of 12%. We would much prefer see growth.
So How Risky Is Newmax Technology?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Newmax Technology lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of NT$778m and booked a NT$175m accounting loss. With only NT$1.50b on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn’t produce free cash flow regularly. For riskier companies like Newmax Technology I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.
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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