Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Montage Technology Co., Ltd. (SHSE:688008) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Montage Technology's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Montage Technology had debt of CN¥18.1m, up from none in one year. But on the other hand it also has CN¥7.36b in cash, leading to a CN¥7.34b net cash position.
A Look At Montage Technology's Liabilities
The latest balance sheet data shows that Montage Technology had liabilities of CN¥386.3m due within a year, and liabilities of CN¥98.5m falling due after that. Offsetting this, it had CN¥7.36b in cash and CN¥260.1m in receivables that were due within 12 months. So it actually has CN¥7.13b more liquid assets than total liabilities.
This surplus suggests that Montage Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Montage Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Montage Technology's saving grace is its low debt levels, because its EBIT has tanked 43% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Montage Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Montage Technology 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, Montage Technology produced sturdy free cash flow equating to 63% 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 Montage Technology has CN¥7.34b in net cash and a decent-looking balance sheet. So we are not troubled with Montage Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Montage Technology you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.