Is Fu Chian TireLtd (GTSM:5102) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Fu Chian Tire Co.,Ltd. (GTSM:5102) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Fu Chian TireLtd

What Is Fu Chian TireLtd's Net Debt?

As you can see below, Fu Chian TireLtd had NT$340.0m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$143.5m in cash leading to net debt of about NT$196.5m.

A Look At Fu Chian TireLtd's Liabilities

The latest balance sheet data shows that Fu Chian TireLtd had liabilities of NT$411.6m due within a year, and liabilities of NT$103.1m falling due after that. Offsetting these obligations, it had cash of NT$143.5m as well as receivables valued at NT$134.9m due within 12 months. So it has liabilities totalling NT$236.3m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Fu Chian TireLtd has a market capitalization of NT$1.07b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Fu Chian TireLtd has a sky high EBITDA ratio of 5.3, implying high debt, but a strong interest coverage of 10.9. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, Fu Chian TireLtd's EBIT fell a jaw-dropping 22% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Fu Chian TireLtd 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, 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. In the last three years, Fu Chian TireLtd created free cash flow amounting to 16% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On the face of it, Fu Chian TireLtd's net debt to EBITDA left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Fu Chian TireLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Fu Chian TireLtd is showing 4 warning signs in our investment analysis , and 1 of those is significant...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

If you decide to trade Fu Chian TireLtd, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.