Is Chian Hsing Forging Industrial (GTSM:4528) A Risky Investment?

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 note that Chian Hsing Forging Industrial Co., Ltd. (GTSM:4528) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chian Hsing Forging Industrial

What Is Chian Hsing Forging Industrial's Debt?

As you can see below, Chian Hsing Forging Industrial had NT$1.30b of debt at September 2020, down from NT$1.41b a year prior. However, it does have NT$708.7m in cash offsetting this, leading to net debt of about NT$594.1m.

How Strong Is Chian Hsing Forging Industrial's Balance Sheet?

We can see from the most recent balance sheet that Chian Hsing Forging Industrial had liabilities of NT$1.05b falling due within a year, and liabilities of NT$752.1m due beyond that. Offsetting these obligations, it had cash of NT$708.7m as well as receivables valued at NT$393.4m due within 12 months. So its liabilities total NT$702.0m more than the combination of its cash and short-term receivables.

Of course, Chian Hsing Forging Industrial has a market capitalization of NT$3.65b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Chian Hsing Forging Industrial's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 21.0 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Chian Hsing Forging Industrial's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Chian Hsing Forging Industrial can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Chian Hsing Forging Industrial recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for Chian Hsing Forging Industrial was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. In particular, EBIT growth rate gives us cold feet. Considering this range of data points, we think Chian Hsing Forging Industrial is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Chian Hsing Forging Industrial (including 1 which is shouldn't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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