These 4 Measures Indicate That Morn Sun Feed Mill (GTSM:1240) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Morn Sun Feed Mill Corp. (GTSM:1240) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Morn Sun Feed Mill

What Is Morn Sun Feed Mill's Debt?

The image below, which you can click on for greater detail, shows that Morn Sun Feed Mill had debt of NT$286.6m at the end of September 2020, a reduction from NT$313.4m over a year. However, it does have NT$381.1m in cash offsetting this, leading to net cash of NT$94.5m.

How Healthy Is Morn Sun Feed Mill's Balance Sheet?

The latest balance sheet data shows that Morn Sun Feed Mill had liabilities of NT$586.8m due within a year, and liabilities of NT$41.4m falling due after that. Offsetting these obligations, it had cash of NT$381.1m as well as receivables valued at NT$340.3m due within 12 months. So it actually has NT$93.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Morn Sun Feed Mill could probably pay off its debt with ease, as its balance sheet is far from stretched. 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 it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Morn Sun Feed Mill has net cash of NT$94.5m, as well as more liquid assets than liabilities. So we don't have any problem with Morn Sun Feed Mill's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Morn Sun Feed Mill is showing 3 warning signs in our investment analysis , 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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