Is Sinmag Equipment (GTSM:1580) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Sinmag Equipment Corporation (GTSM:1580) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sinmag Equipment

How Much Debt Does Sinmag Equipment Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Sinmag Equipment had debt of NT$229.3m, up from NT$191.7m in one year. But on the other hand it also has NT$601.0m in cash, leading to a NT$371.6m net cash position.

How Healthy Is Sinmag Equipment's Balance Sheet?

According to the last reported balance sheet, Sinmag Equipment had liabilities of NT$894.9m due within 12 months, and liabilities of NT$69.9m due beyond 12 months. On the other hand, it had cash of NT$601.0m and NT$410.9m worth of receivables due within a year. So it can boast NT$47.0m more liquid assets than total liabilities.

This state of affairs indicates that Sinmag Equipment's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$4.52b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Sinmag Equipment has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sinmag Equipment's load is not too heavy, because its EBIT was down 24% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sinmag Equipment 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. While Sinmag Equipment 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, Sinmag Equipment produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Sinmag Equipment has NT$371.6m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in NT$439m. So we are not troubled with Sinmag Equipment's debt use. 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. For example, we've discovered 2 warning signs for Sinmag Equipment (1 is potentially serious!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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