These 4 Measures Indicate That Dynamic Precision Industry (GTSM:8928) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Dynamic Precision Industry Corporation (GTSM:8928) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Dynamic Precision Industry

What Is Dynamic Precision Industry's Net Debt?

As you can see below, at the end of September 2020, Dynamic Precision Industry had NT$770.4m of debt, up from NT$735.0m a year ago. Click the image for more detail. On the flip side, it has NT$101.5m in cash leading to net debt of about NT$668.9m.

A Look At Dynamic Precision Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Dynamic Precision Industry had liabilities of NT$1.19b due within 12 months and liabilities of NT$159.9m due beyond that. On the other hand, it had cash of NT$101.5m and NT$533.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$719.5m.

While this might seem like a lot, it is not so bad since Dynamic Precision Industry has a market capitalization of NT$1.45b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dynamic Precision Industry's net debt is 3.2 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 14.9 is very high, suggesting that the interest expense on the debt is currently quite low. Notably Dynamic Precision Industry's EBIT was pretty flat over the last year. We would prefer to see some earnings growth, because that always helps diminish debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dynamic Precision Industry'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Dynamic Precision Industry reported free cash flow worth 7.8% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Neither Dynamic Precision Industry's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its interest cover tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Dynamic Precision Industry's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Like risks, for instance. Every company has them, and we've spotted 4 warning signs for Dynamic Precision Industry (of which 2 can't be ignored!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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