Is Chen Nan Iron Wire (GTSM:2071) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Chen Nan Iron Wire Co., Ltd. (GTSM:2071) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Chen Nan Iron Wire

What Is Chen Nan Iron Wire's Net Debt?

The chart below, which you can click on for greater detail, shows that Chen Nan Iron Wire had NT$1.53b in debt in June 2020; about the same as the year before. However, it also had NT$145.3m in cash, and so its net debt is NT$1.39b.

A Look At Chen Nan Iron Wire's Liabilities

According to the last reported balance sheet, Chen Nan Iron Wire had liabilities of NT$1.10b due within 12 months, and liabilities of NT$988.5m due beyond 12 months. Offsetting these obligations, it had cash of NT$145.3m as well as receivables valued at NT$345.9m due within 12 months. So its liabilities total NT$1.60b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$869.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Chen Nan Iron Wire would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chen Nan Iron Wire'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, Chen Nan Iron Wire made a loss at the EBIT level, and saw its revenue drop to NT$1.5b, which is a fall of 16%. That's not what we would hope to see.

Caveat Emptor

Not only did Chen Nan Iron Wire's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$20m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of NT$44m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. For example, we've discovered 3 warning signs for Chen Nan Iron Wire (2 are significant!) that you should be aware of before investing here.

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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