We Think Gongin Precision Ind (GTSM:3178) Can Stay On Top Of Its Debt

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.' 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. Importantly, Gongin Precision Ind. Co., Ltd (GTSM:3178) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Gongin Precision Ind

What Is Gongin Precision Ind's Debt?

As you can see below, Gongin Precision Ind had NT$789.9m of debt at December 2020, down from NT$833.3m a year prior. On the flip side, it has NT$162.6m in cash leading to net debt of about NT$627.2m.

How Strong Is Gongin Precision Ind's Balance Sheet?

We can see from the most recent balance sheet that Gongin Precision Ind had liabilities of NT$541.1m falling due within a year, and liabilities of NT$740.6m due beyond that. On the other hand, it had cash of NT$162.6m and NT$258.0m worth of receivables due within a year. So its liabilities total NT$861.1m more than the combination of its cash and short-term receivables.

Gongin Precision Ind has a market capitalization of NT$4.19b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Gongin Precision Ind's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its strong interest cover of 10.9 times, makes us even more comfortable. Notably, Gongin Precision Ind's EBIT launched higher than Elon Musk, gaining a whopping 103% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Gongin Precision Ind 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Gongin Precision Ind actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Both Gongin Precision Ind's ability to to grow its EBIT and its interest cover gave us comfort that it can handle its debt. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. Considering this range of data points, we think Gongin Precision Ind is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Gongin Precision Ind (of which 1 makes us a bit uncomfortable!) 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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