Goodway Machine (TPE:1583) Has A Somewhat Strained Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Goodway Machine Corp. (TPE:1583) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Goodway Machine

How Much Debt Does Goodway Machine Carry?

The image below, which you can click on for greater detail, shows that Goodway Machine had debt of NT$4.21b at the end of September 2020, a reduction from NT$4.90b over a year. However, it does have NT$2.42b in cash offsetting this, leading to net debt of about NT$1.80b.

A Look At Goodway Machine's Liabilities

Zooming in on the latest balance sheet data, we can see that Goodway Machine had liabilities of NT$5.67b due within 12 months and liabilities of NT$536.0m due beyond that. Offsetting this, it had NT$2.42b in cash and NT$1.74b in receivables that were 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 Goodway Machine has a market capitalization of NT$6.79b, 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 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).

With a net debt to EBITDA ratio of 7.0, it's fair to say Goodway Machine does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 5.9 times, suggesting it can responsibly service its obligations. Shareholders should be aware that Goodway Machine's EBIT was down 85% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Goodway Machine 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.

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 most recent three years, Goodway Machine recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

While Goodway Machine's net debt to EBITDA makes us cautious about it, its track record of (not) growing its EBIT is no better. But on the brighter side of life, its conversion of EBIT to free cash flow leaves us feeling more frolicsome. We think that Goodway Machine's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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, we've discovered 4 warning signs for Goodway Machine (2 are potentially serious!) that you should be aware of before investing here.

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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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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