Here's Why OFCO Industrial (GTSM:5011) 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.' 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 OFCO Industrial Corporation (GTSM:5011) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for OFCO Industrial

What Is OFCO Industrial's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 OFCO Industrial had debt of NT$1.10b, up from NT$760.8m in one year. On the flip side, it has NT$392.6m in cash leading to net debt of about NT$704.6m.

How Healthy Is OFCO Industrial's Balance Sheet?

We can see from the most recent balance sheet that OFCO Industrial had liabilities of NT$1.04b falling due within a year, and liabilities of NT$346.6m due beyond that. Offsetting these obligations, it had cash of NT$392.6m as well as receivables valued at NT$340.5m due within 12 months. So its liabilities total NT$652.8m more than the combination of its cash and short-term receivables.

OFCO Industrial has a market capitalization of NT$1.22b, 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is OFCO Industrial'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, OFCO Industrial reported revenue of NT$1.3b, which is a gain of 6.5%, although it did not report any earnings before interest and tax. 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 OFCO Industrial produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at NT$95m. 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$46m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for OFCO Industrial (2 are significant) you should be aware of.

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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