Ever-Clear Environmental Eng (GTSM:6624) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Ever-Clear Environmental Eng. Corp. (GTSM:6624) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ever-Clear Environmental Eng

What Is Ever-Clear Environmental Eng's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Ever-Clear Environmental Eng had NT$294.6m of debt, an increase on NT$248.0m, over one year. On the flip side, it has NT$44.5m in cash leading to net debt of about NT$250.0m.

How Healthy Is Ever-Clear Environmental Eng's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ever-Clear Environmental Eng had liabilities of NT$196.8m due within 12 months and liabilities of NT$210.0m due beyond that. Offsetting these obligations, it had cash of NT$44.5m as well as receivables valued at NT$293.6m due within 12 months. So its liabilities total NT$68.6m more than the combination of its cash and short-term receivables.

Since publicly traded Ever-Clear Environmental Eng shares are worth a total of NT$636.3m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ever-Clear Environmental Eng shareholders face the double whammy of a high net debt to EBITDA ratio (17.4), and fairly weak interest coverage, since EBIT is just 1.9 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Ever-Clear Environmental Eng saw its EBIT tank 95% over the last 12 months. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ever-Clear Environmental Eng'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Ever-Clear Environmental Eng 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

To be frank both Ever-Clear Environmental Eng'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. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Overall, it seems to us that Ever-Clear Environmental Eng's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Ever-Clear Environmental Eng (of which 1 shouldn't be ignored!) you should know about.

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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