New Best Wire IndustrialLtd (GTSM:5013) Has A Somewhat Strained Balance Sheet

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. We can see that New Best Wire Industrial Co.,Ltd (GTSM:5013) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for New Best Wire IndustrialLtd

How Much Debt Does New Best Wire IndustrialLtd Carry?

The chart below, which you can click on for greater detail, shows that New Best Wire IndustrialLtd had NT$3.12b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of NT$755.1m, its net debt is less, at about NT$2.36b.

How Strong Is New Best Wire IndustrialLtd's Balance Sheet?

According to the last reported balance sheet, New Best Wire IndustrialLtd had liabilities of NT$1.62b due within 12 months, and liabilities of NT$1.98b due beyond 12 months. Offsetting this, it had NT$755.1m in cash and NT$1.34b in receivables that were due within 12 months. So it has liabilities totalling NT$1.51b more than its cash and near-term receivables, combined.

New Best Wire IndustrialLtd has a market capitalization of NT$3.66b, 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 use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt to EBITDA of 3.7 New Best Wire IndustrialLtd has a fairly noticeable amount of debt. On the plus side, its EBIT was 8.6 times its interest expense, and its net debt to EBITDA, was quite high, at 3.7. If New Best Wire IndustrialLtd can keep growing EBIT at last year's rate of 13% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since New Best Wire IndustrialLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, New Best Wire IndustrialLtd recorded free cash flow of 22% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

While New Best Wire IndustrialLtd's net debt to EBITDA does give us pause, its interest cover and EBIT growth rate suggest it can stay on top of its debt load. We think that New Best Wire IndustrialLtd's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. To that end, you should learn about the 2 warning signs we've spotted with New Best Wire IndustrialLtd (including 1 which is a bit concerning) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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