Here's Why RAC Electric Vehicles (GTSM:2237) Can Afford Some 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. We can see that RAC Electric Vehicles Inc. (GTSM:2237) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for RAC Electric Vehicles

How Much Debt Does RAC Electric Vehicles Carry?

The image below, which you can click on for greater detail, shows that RAC Electric Vehicles had debt of NT$81.4m at the end of June 2020, a reduction from NT$115.6m over a year. However, it also had NT$72.8m in cash, and so its net debt is NT$8.56m.

How Healthy Is RAC Electric Vehicles's Balance Sheet?

We can see from the most recent balance sheet that RAC Electric Vehicles had liabilities of NT$217.8m falling due within a year, and liabilities of NT$22.2m due beyond that. Offsetting these obligations, it had cash of NT$72.8m as well as receivables valued at NT$41.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$126.0m.

Of course, RAC Electric Vehicles has a market capitalization of NT$1.96b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. But either way, RAC Electric Vehicles has virtually no net debt, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since RAC Electric Vehicles 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.

Over 12 months, RAC Electric Vehicles made a loss at the EBIT level, and saw its revenue drop to NT$45m, which is a fall of 84%. That makes us nervous, to say the least.

Caveat Emptor

Not only did RAC Electric Vehicles'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$174m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NT$43m of cash over the last year. So suffice it to say we do 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. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for RAC Electric Vehicles you should know about.

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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