Would Yao I Fabric (GTSM:4430) Be Better Off With Less Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Yao I Fabric Co., Ltd. (GTSM:4430) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Yao I Fabric

What Is Yao I Fabric's Net Debt?

As you can see below, at the end of September 2020, Yao I Fabric had NT$1.37b of debt, up from NT$970.5m a year ago. Click the image for more detail. However, because it has a cash reserve of NT$808.5m, its net debt is less, at about NT$557.2m.

How Healthy Is Yao I Fabric's Balance Sheet?

According to the last reported balance sheet, Yao I Fabric had liabilities of NT$1.72b due within 12 months, and liabilities of NT$216.3m due beyond 12 months. Offsetting this, it had NT$808.5m in cash and NT$429.0m in receivables that were due within 12 months. So its liabilities total NT$698.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Yao I Fabric is worth NT$1.33b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Yao I Fabric 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.

Over 12 months, Yao I Fabric made a loss at the EBIT level, and saw its revenue drop to NT$1.9b, which is a fall of 8.8%. That's not what we would hope to see.

Caveat Emptor

Importantly, Yao I Fabric had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost NT$100m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled NT$585m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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 3 warning signs for Yao I Fabric (1 is a bit unpleasant!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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