These 4 Measures Indicate That Mechema Chemicals International (GTSM:4721) Is Using Debt Reasonably Well

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Mechema Chemicals International Corp. (GTSM:4721) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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.

Check out our latest analysis for Mechema Chemicals International

How Much Debt Does Mechema Chemicals International Carry?

The image below, which you can click on for greater detail, shows that Mechema Chemicals International had debt of NT$275.8m at the end of December 2020, a reduction from NT$641.0m over a year. However, its balance sheet shows it holds NT$360.6m in cash, so it actually has NT$84.8m net cash.

How Strong Is Mechema Chemicals International's Balance Sheet?

The latest balance sheet data shows that Mechema Chemicals International had liabilities of NT$408.8m due within a year, and liabilities of NT$3.40m falling due after that. Offsetting this, it had NT$360.6m in cash and NT$396.2m in receivables that were due within 12 months. So it can boast NT$344.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Mechema Chemicals International could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Mechema Chemicals International 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 Mechema Chemicals International if management cannot prevent a repeat of the 35% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Mechema Chemicals International'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. While Mechema Chemicals International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Mechema Chemicals International 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 we empathize with investors who find debt concerning, you should keep in mind that Mechema Chemicals International has net cash of NT$84.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$362m, being 201% of its EBIT. So we don't have any problem with Mechema Chemicals International's use of debt. 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. For instance, we've identified 1 warning sign for Mechema Chemicals International that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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