We Think Xin Chio Global (GTSM:3171) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Xin Chio Global Co., Ltd. (GTSM:3171) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Xin Chio Global

How Much Debt Does Xin Chio Global Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Xin Chio Global had debt of NT$449.7m, up from NT$323.5m in one year. However, because it has a cash reserve of NT$256.3m, its net debt is less, at about NT$193.4m.

How Healthy Is Xin Chio Global's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Xin Chio Global had liabilities of NT$681.5m due within 12 months and liabilities of NT$184.6m due beyond that. On the other hand, it had cash of NT$256.3m and NT$511.0m worth of receivables due within a year. So its liabilities total NT$98.7m more than the combination of its cash and short-term receivables.

Given Xin Chio Global has a market capitalization of NT$1.25b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Xin Chio Global has a low debt to EBITDA ratio of only 1.3. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. In addition to that, we're happy to report that Xin Chio Global has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Xin Chio Global 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Xin Chio Global actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Happily, Xin Chio Global's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that Xin Chio Global is quite prudent with its debt, and the risks seem well managed. So we're not worried about the use of a little leverage on the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Xin Chio Global 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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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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