Is Gourmet Master (TPE:2723) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Gourmet Master Co. Ltd. (TPE:2723) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gourmet Master

How Much Debt Does Gourmet Master Carry?

As you can see below, at the end of December 2020, Gourmet Master had NT$1.01b of debt, up from NT$552.9m a year ago. Click the image for more detail. But it also has NT$6.35b in cash to offset that, meaning it has NT$5.34b net cash.

A Look At Gourmet Master's Liabilities

According to the last reported balance sheet, Gourmet Master had liabilities of NT$7.16b due within 12 months, and liabilities of NT$4.34b due beyond 12 months. On the other hand, it had cash of NT$6.35b and NT$544.8m worth of receivables due within a year. So its liabilities total NT$4.61b more than the combination of its cash and short-term receivables.

Given Gourmet Master has a market capitalization of NT$33.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Gourmet Master also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Gourmet Master saw its EBIT decline by 6.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Gourmet Master's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Gourmet Master 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. Happily for any shareholders, Gourmet Master actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Gourmet Master does have more liabilities than liquid assets, it also has net cash of NT$5.34b. And it impressed us with free cash flow of NT$2.5b, being 129% of its EBIT. So is Gourmet Master's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. 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 2 warning signs for Gourmet Master you should know about.

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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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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