GeneFerm Biotechnology (GTSM:1796) Takes On Some Risk With Its Use Of Debt

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 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. We can see that GeneFerm Biotechnology Co., Ltd. (GTSM:1796) does use debt in its business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.

Check out our latest analysis for GeneFerm Biotechnology

What Is GeneFerm Biotechnology's Debt?

You can click the graphic below for the historical numbers, but it shows that GeneFerm Biotechnology had NT$397.6m of debt in December 2020, down from NT$439.0m, one year before. However, it does have NT$348.0m in cash offsetting this, leading to net debt of about NT$49.6m.

A Look At GeneFerm Biotechnology's Liabilities

The latest balance sheet data shows that GeneFerm Biotechnology had liabilities of NT$115.8m due within a year, and liabilities of NT$470.5m falling due after that. On the other hand, it had cash of NT$348.0m and NT$73.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$164.5m.

Given GeneFerm Biotechnology has a market capitalization of NT$948.4m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Given net debt is only 0.96 times EBITDA, it is initially surprising to see that GeneFerm Biotechnology's EBIT has low interest coverage of 1.8 times. So one way or the other, it's clear the debt levels are not trivial. Notably, GeneFerm Biotechnology made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$17m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is GeneFerm Biotechnology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, GeneFerm Biotechnology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While GeneFerm Biotechnology's interest cover makes us cautious about it, its track record of converting EBIT to free cash flow is no better. But its not so bad at managing its debt, based on its EBITDA,. When we consider all the factors discussed, it seems to us that GeneFerm Biotechnology is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. Be aware that GeneFerm Biotechnology is showing 4 warning signs in our investment analysis , and 2 of those are significant...

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.

If you’re looking to trade GeneFerm Biotechnology, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade 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.