Health Check: How Prudently Does Falcon Machine Tools (GTSM:4513) Use 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Falcon Machine Tools Co., Ltd. (GTSM:4513) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Falcon Machine Tools

What Is Falcon Machine Tools's Net Debt?

The image below, which you can click on for greater detail, shows that Falcon Machine Tools had debt of NT$1.02b at the end of September 2020, a reduction from NT$1.07b over a year. However, it does have NT$311.8m in cash offsetting this, leading to net debt of about NT$711.0m.

A Look At Falcon Machine Tools' Liabilities

Zooming in on the latest balance sheet data, we can see that Falcon Machine Tools had liabilities of NT$845.3m due within 12 months and liabilities of NT$669.5m due beyond that. Offsetting this, it had NT$311.8m in cash and NT$226.2m in receivables that were due within 12 months. So its liabilities total NT$976.7m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$676.5m, we think shareholders really should watch Falcon Machine Tools's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. There's no doubt that we learn most about debt from the balance sheet. But it is Falcon Machine Tools'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, Falcon Machine Tools made a loss at the EBIT level, and saw its revenue drop to NT$1.1b, which is a fall of 21%. That makes us nervous, to say the least.

Caveat Emptor

While Falcon Machine Tools's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$36m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of NT$40m. In the meantime, we consider the stock to be risky. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Falcon Machine Tools (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

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.

If you decide to trade Falcon Machine Tools, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.