Stock Analysis

Is Morn Sun Feed Mill (GTSM:1240) A Risky Investment?

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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Morn Sun Feed Mill Co., Ltd. (GTSM:1240) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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.

View our latest analysis for Morn Sun Feed Mill

How Much Debt Does Morn Sun Feed Mill Carry?

As you can see below, Morn Sun Feed Mill had NT$286.6m of debt at September 2020, down from NT$313.4m a year prior. However, it does have NT$381.1m in cash offsetting this, leading to net cash of NT$94.5m.

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GTSM:1240 Debt to Equity History December 3rd 2020

A Look At Morn Sun Feed Mill's Liabilities

We can see from the most recent balance sheet that Morn Sun Feed Mill had liabilities of NT$586.8m falling due within a year, and liabilities of NT$41.4m due beyond that. Offsetting this, it had NT$381.1m in cash and NT$340.3m in receivables that were due within 12 months. So it actually has NT$93.2m more liquid assets than total liabilities.

This surplus suggests that Morn Sun Feed Mill has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Morn Sun Feed Mill has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Morn Sun Feed Mill if management cannot prevent a repeat of the 38% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Morn Sun Feed Mill'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Morn Sun Feed Mill 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 last three years, Morn Sun Feed Mill reported free cash flow worth 9.4% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Morn Sun Feed Mill has NT$94.5m in net cash and a decent-looking balance sheet. So we are not troubled with Morn Sun Feed Mill's debt use. 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. Take risks, for example - Morn Sun Feed Mill has 3 warning signs we think you should be aware of.

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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