Is Chumpower Machinery (GTSM:4575) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Chumpower Machinery Corporation (GTSM:4575) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Chumpower Machinery

What Is Chumpower Machinery's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Chumpower Machinery had debt of NT$1.29b, up from NT$796.4m in one year. However, because it has a cash reserve of NT$506.9m, its net debt is less, at about NT$784.9m.

How Healthy Is Chumpower Machinery's Balance Sheet?

The latest balance sheet data shows that Chumpower Machinery had liabilities of NT$1.39b due within a year, and liabilities of NT$740.8m falling due after that. Offsetting these obligations, it had cash of NT$506.9m as well as receivables valued at NT$110.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.51b.

The deficiency here weighs heavily on the NT$972.5m 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. After all, Chumpower Machinery would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chumpower Machinery'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.

In the last year Chumpower Machinery wasn't profitable at an EBIT level, but managed to grow its revenue by 2.4%, to NT$943m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Chumpower Machinery produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at NT$12m. 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. Not least because it burned through NT$72m in negative free cash flow over the last year. So suffice it to say 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. To that end, you should learn about the 5 warning signs we've spotted with Chumpower Machinery (including 2 which are a bit concerning) .

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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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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