We Think Up Young Cornerstone (GTSM:6728) Can Stay On Top Of Its Debt

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Up Young Cornerstone Corp. (GTSM:6728) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Up Young Cornerstone

What Is Up Young Cornerstone's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Up Young Cornerstone had NT$214.3m of debt in September 2020, down from NT$269.0m, one year before. On the flip side, it has NT$86.1m in cash leading to net debt of about NT$128.2m.

A Look At Up Young Cornerstone's Liabilities

Zooming in on the latest balance sheet data, we can see that Up Young Cornerstone had liabilities of NT$383.4m due within 12 months and liabilities of NT$99.5m due beyond that. On the other hand, it had cash of NT$86.1m and NT$114.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$282.2m.

While this might seem like a lot, it is not so bad since Up Young Cornerstone has a market capitalization of NT$1.26b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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 has a low net debt to EBITDA ratio of only 0.74. And its EBIT easily covers its interest expense, being 23.0 times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Up Young Cornerstone grew its EBIT by 63% over the last twelve months, and that growth will make it easier to handle its debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Up Young Cornerstone reported free cash flow worth 15% of its EBIT, which is really quite low. 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 truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. When we consider the range of factors above, it looks like Up Young Cornerstone is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Take risks, for example - Up Young Cornerstone has 4 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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