Is Brighton-Best International (Taiwan) (GTSM:8415) Using Too Much 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.' 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. As with many other companies Brighton-Best International (Taiwan) Inc. (GTSM:8415) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Brighton-Best International (Taiwan)

What Is Brighton-Best International (Taiwan)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Brighton-Best International (Taiwan) had NT$11.1b of debt, an increase on NT$9.48b, over one year. However, it does have NT$4.84b in cash offsetting this, leading to net debt of about NT$6.29b.

How Strong Is Brighton-Best International (Taiwan)'s Balance Sheet?

We can see from the most recent balance sheet that Brighton-Best International (Taiwan) had liabilities of NT$10.6b falling due within a year, and liabilities of NT$4.97b due beyond that. Offsetting these obligations, it had cash of NT$4.84b as well as receivables valued at NT$4.33b due within 12 months. So its liabilities total NT$6.44b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Brighton-Best International (Taiwan) is worth NT$29.7b, and thus could probably raise enough capital to shore up 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Brighton-Best International (Taiwan) has a debt to EBITDA ratio of 3.9 and its EBIT covered its interest expense 6.6 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Unfortunately, Brighton-Best International (Taiwan)'s EBIT flopped 12% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. But it is Brighton-Best International (Taiwan)'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Brighton-Best International (Taiwan) burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We'd go so far as to say Brighton-Best International (Taiwan)'s conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Brighton-Best International (Taiwan)'s use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Brighton-Best International (Taiwan) you should know about.

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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