Genes Tech Group Holdings (HKG:8257) Has A Somewhat Strained Balance Sheet

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.' 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 Genes Tech Group Holdings Company Limited (HKG:8257) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Genes Tech Group Holdings

How Much Debt Does Genes Tech Group Holdings Carry?

The chart below, which you can click on for greater detail, shows that Genes Tech Group Holdings had NT$649.3m in debt in June 2023; about the same as the year before. However, it also had NT$106.1m in cash, and so its net debt is NT$543.1m.

How Strong Is Genes Tech Group Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Genes Tech Group Holdings had liabilities of NT$1.28b due within 12 months and liabilities of NT$191.5m due beyond that. Offsetting these obligations, it had cash of NT$106.1m as well as receivables valued at NT$224.7m due within 12 months. So its liabilities total NT$1.14b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$327.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Genes Tech Group Holdings would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Genes Tech Group Holdings has a debt to EBITDA ratio of 2.5, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 11.0 is very high, suggesting that the interest expense on the debt is currently quite low. Also relevant is that Genes Tech Group Holdings has grown its EBIT by a very respectable 24% in the last year, thus enhancing its ability to pay down debt. 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 Genes Tech Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Genes Tech Group Holdings recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Genes Tech Group Holdings's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example its interest cover was refreshing. When we consider all the factors discussed, it seems to us that Genes Tech Group Holdings is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for Genes Tech Group Holdings you should be aware of, and 3 of them are a bit concerning.

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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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.