Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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 note that Golden Friends Corporation (GTSM:4506) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
See our latest analysis for Golden Friends
What Is Golden Friends’s Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Golden Friends had debt of NT$100.0m, up from none in one year. But it also has NT$1.89b in cash to offset that, meaning it has NT$1.79b net cash.
A Look At Golden Friends’s Liabilities
Zooming in on the latest balance sheet data, we can see that Golden Friends had liabilities of NT$3.39b due within 12 months and liabilities of NT$33.6m due beyond that. Offsetting this, it had NT$1.89b in cash and NT$957.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$581.6m.
Given Golden Friends has a market capitalization of NT$9.95b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Golden Friends boasts net cash, so it’s fair to say it does not have a heavy debt load!
Golden Friends’s EBIT was pretty flat over the last year, but that shouldn’t be an issue given the it doesn’t have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Golden Friends’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. Golden Friends 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. Over the most recent three years, Golden Friends recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing up
We could understand if investors are concerned about Golden Friends’s liabilities, but we can be reassured by the fact it has has net cash of NT$1.79b. And it impressed us with free cash flow of NT$538m, being 78% of its EBIT. So we don’t think Golden Friends’s use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Golden Friends’s dividend history, without delay!
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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