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. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Good Way Technology Co., Ltd. (GTSM:3272) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
View our latest analysis for Good Way Technology
What Is Good Way Technology’s Net Debt?
The image below, which you can click on for greater detail, shows that at December 2019 Good Way Technology had debt of NT$708.8m, up from NT$612.8m in one year. However, because it has a cash reserve of NT$406.9m, its net debt is less, at about NT$301.9m.
How Healthy Is Good Way Technology’s Balance Sheet?
We can see from the most recent balance sheet that Good Way Technology had liabilities of NT$1.87b falling due within a year, and liabilities of NT$538.8m due beyond that. Offsetting these obligations, it had cash of NT$406.9m as well as receivables valued at NT$1.35b due within 12 months. So its liabilities total NT$648.7m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of NT$964.2m, so it does suggest shareholders should keep an eye on Good Way Technology’s use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
With net debt sitting at just 1.4 times EBITDA, Good Way Technology is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.6 times the interest expense over the last year. In addition to that, we’re happy to report that Good Way Technology has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Good Way 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. During the last three years, Good Way Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Good Way Technology’s conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Looking at all the angles mentioned above, it does seem to us that Good Way Technology is a somewhat risky investment as a result of its debt. That’s not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we’ve spotted 5 warning signs for Good Way Technology (of which 2 are concerning!) 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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