Is Great Tree Pharmacy (GTSM:6469) A Risky Investment?

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 Great Tree Pharmacy Co., Ltd. (GTSM:6469) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Great Tree Pharmacy

What Is Great Tree Pharmacy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Great Tree Pharmacy had NT$426.7m of debt, an increase on NT$226.3m, over one year. However, its balance sheet shows it holds NT$660.7m in cash, so it actually has NT$234.0m net cash.

A Look At Great Tree Pharmacy's Liabilities

We can see from the most recent balance sheet that Great Tree Pharmacy had liabilities of NT$2.02b falling due within a year, and liabilities of NT$2.25b due beyond that. Offsetting this, it had NT$660.7m in cash and NT$385.1m in receivables that were due within 12 months. So it has liabilities totalling NT$3.23b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of NT$5.26b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Great Tree Pharmacy also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Great Tree Pharmacy has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Great Tree Pharmacy'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. Great Tree Pharmacy may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Great Tree Pharmacy recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

Although Great Tree Pharmacy's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$234.0m. And we liked the look of last year's 25% year-on-year EBIT growth. So we are not troubled with Great Tree Pharmacy's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Great Tree Pharmacy 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.

When trading Great Tree Pharmacy or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.