Is I Yuan Precision Industrial (GTSM:2235) A Risky Investment?

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 I Yuan Precision Industrial Co., Ltd. (GTSM:2235) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for I Yuan Precision Industrial

What Is I Yuan Precision Industrial's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 I Yuan Precision Industrial had debt of NT$79.0m, up from NT$47.0m in one year. However, it also had NT$26.2m in cash, and so its net debt is NT$52.8m.

How Strong Is I Yuan Precision Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that I Yuan Precision Industrial had liabilities of NT$242.4m due within 12 months and liabilities of NT$102.2m due beyond that. Offsetting these obligations, it had cash of NT$26.2m as well as receivables valued at NT$250.9m due within 12 months. So it has liabilities totalling NT$67.5m more than its cash and near-term receivables, combined.

Since publicly traded I Yuan Precision Industrial shares are worth a total of NT$1.64b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

I Yuan Precision Industrial's net debt is only 0.37 times its EBITDA. And its EBIT covers its interest expense a whopping 59.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In fact I Yuan Precision Industrial's saving grace is its low debt levels, because its EBIT has tanked 51% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since I Yuan Precision Industrial 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, I Yuan Precision Industrial actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that I Yuan Precision Industrial's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. Looking at all the aforementioned factors together, it strikes us that I Yuan Precision Industrial can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that I Yuan Precision Industrial is showing 4 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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. 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.
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