Kuo Toong International (GTSM:8936) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Kuo Toong International Co., Ltd. (GTSM:8936) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kuo Toong International

What Is Kuo Toong International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Kuo Toong International had NT$3.53b of debt in September 2020, down from NT$3.81b, one year before. However, it does have NT$1.43b in cash offsetting this, leading to net debt of about NT$2.10b.

How Strong Is Kuo Toong International's Balance Sheet?

According to the last reported balance sheet, Kuo Toong International had liabilities of NT$3.94b due within 12 months, and liabilities of NT$1.57b due beyond 12 months. Offsetting these obligations, it had cash of NT$1.43b as well as receivables valued at NT$2.03b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.05b.

While this might seem like a lot, it is not so bad since Kuo Toong International has a market capitalization of NT$5.88b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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).

Kuo Toong International's debt is 4.7 times its EBITDA, and its EBIT cover its interest expense 4.3 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Worse, Kuo Toong International's EBIT was down 32% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kuo Toong International will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Kuo Toong International burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Kuo Toong International's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. Having said that, its ability to handle its total liabilities isn't such a worry. Overall, it seems to us that Kuo Toong International's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 3 warning signs we've spotted with Kuo Toong International (including 1 which is is concerning) .

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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