Group Up Industrial (GTSM:6664) Has A Rock Solid Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Group Up Industrial Co., Ltd. (GTSM:6664) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Group Up Industrial

What Is Group Up Industrial's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Group Up Industrial had NT$368.3m of debt, an increase on NT$148.9m, over one year. But on the other hand it also has NT$1.35b in cash, leading to a NT$979.3m net cash position.

How Healthy Is Group Up Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Group Up Industrial had liabilities of NT$1.63b due within 12 months and liabilities of NT$117.4m due beyond that. On the other hand, it had cash of NT$1.35b and NT$294.8m worth of receivables due within a year. So it has liabilities totalling NT$107.1m more than its cash and near-term receivables, combined.

Of course, Group Up Industrial has a market capitalization of NT$3.50b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Group Up Industrial also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Group Up Industrial grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Group Up 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Group Up Industrial may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Group Up Industrial actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Group Up Industrial's liabilities, but we can be reassured by the fact it has has net cash of NT$979.3m. The cherry on top was that in converted 108% of that EBIT to free cash flow, bringing in NT$361m. So is Group Up Industrial's debt a risk? It doesn't seem so to us. 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. For example - Group Up Industrial has 1 warning sign we think you should be aware of.

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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