Up Young Cornerstone (GTSM:6728) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Up Young Cornerstone Corp. (GTSM:6728) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Up Young Cornerstone

What Is Up Young Cornerstone's Net Debt?

The image below, which you can click on for greater detail, shows that Up Young Cornerstone had debt of NT$241.0m at the end of September 2020, a reduction from NT$269.0m over a year. However, it does have NT$86.1m in cash offsetting this, leading to net debt of about NT$154.9m.

A Look At Up Young Cornerstone's Liabilities

According to the last reported balance sheet, Up Young Cornerstone had liabilities of NT$383.4m due within 12 months, and liabilities of NT$99.5m due beyond 12 months. Offsetting this, it had NT$86.1m in cash and NT$114.6m in receivables that were due within 12 months. So it has liabilities totalling NT$282.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Up Young Cornerstone is worth NT$1.17b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Up Young Cornerstone's net debt is only 0.91 times its EBITDA. And its EBIT covers its interest expense a whopping 23.0 times over. So we're pretty relaxed about its super-conservative use of debt. Better yet, Up Young Cornerstone grew its EBIT by 139% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Up Young Cornerstone 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Up Young Cornerstone created free cash flow amounting to 2.3% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

The good news is that Up Young Cornerstone's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Up Young Cornerstone can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 4 warning signs for Up Young Cornerstone that 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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