Is Her Chee Industrial (GTSM:8937) Using Too Much Debt?

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. Importantly, Her Chee Industrial Co., Ltd. (GTSM:8937) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Her Chee Industrial

What Is Her Chee Industrial's Net Debt?

As you can see below, at the end of December 2020, Her Chee Industrial had NT$169.5m of debt, up from none a year ago. Click the image for more detail. But it also has NT$419.6m in cash to offset that, meaning it has NT$250.1m net cash.

How Healthy Is Her Chee Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Her Chee Industrial had liabilities of NT$200.8m due within 12 months and liabilities of NT$45.9m due beyond that. On the other hand, it had cash of NT$419.6m and NT$16.6m worth of receivables due within a year. So it can boast NT$189.4m more liquid assets than total liabilities.

It's good to see that Her Chee Industrial has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Her Chee Industrial has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Her Chee Industrial's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Her Chee Industrial made a loss at the EBIT level, and saw its revenue drop to NT$283m, which is a fall of 9.8%. That's not what we would hope to see.

So How Risky Is Her Chee Industrial?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Her Chee Industrial had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through NT$50m of cash and made a loss of NT$3.5m. Given it only has net cash of NT$250.1m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Her Chee Industrial (1 makes us a bit uncomfortable) you should be aware of.

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.

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