Here's Why Macauto Industrial (GTSM:9951) Can Manage Its Debt Responsibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Macauto Industrial Co., Ltd. (GTSM:9951) does carry debt. But is this debt a concern to shareholders?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Macauto Industrial

What Is Macauto Industrial's Debt?

You can click the graphic below for the historical numbers, but it shows that Macauto Industrial had NT$509.6m of debt in September 2020, down from NT$666.8m, one year before. However, its balance sheet shows it holds NT$1.09b in cash, so it actually has NT$583.1m net cash.

How Healthy Is Macauto Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Macauto Industrial had liabilities of NT$1.80b due within 12 months and liabilities of NT$469.1m due beyond that. Offsetting this, it had NT$1.09b in cash and NT$1.08b in receivables that were due within 12 months. So its liabilities total NT$97.7m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Macauto Industrial's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$6.41b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Macauto Industrial also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Macauto Industrial's load is not too heavy, because its EBIT was down 28% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Macauto Industrial can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Macauto Industrial has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Macauto Industrial generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Macauto Industrial has NT$583.1m in net cash. And it impressed us with free cash flow of NT$698m, being 97% of its EBIT. So we are not troubled with Macauto Industrial's debt use. 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 example, we've discovered 1 warning sign for Macauto Industrial that you should be aware of before investing here.

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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