We Think Mechema Chemicals International (GTSM:4721) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Mechema Chemicals International Corp. (GTSM:4721) does carry 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Mechema Chemicals International

What Is Mechema Chemicals International's Net Debt?

As you can see below, Mechema Chemicals International had NT$409.9m of debt at September 2020, down from NT$671.0m a year prior. On the flip side, it has NT$326.4m in cash leading to net debt of about NT$83.5m.

How Healthy Is Mechema Chemicals International's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mechema Chemicals International had liabilities of NT$531.5m due within 12 months and liabilities of NT$3.52m due beyond that. On the other hand, it had cash of NT$326.4m and NT$544.2m worth of receivables due within a year. So it can boast NT$335.6m more liquid assets than total liabilities.

This surplus suggests that Mechema Chemicals International has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Mechema Chemicals International's net debt is only 0.38 times its EBITDA. And its EBIT covers its interest expense a whopping 120 times over. So we're pretty relaxed about its super-conservative use of debt. Fortunately, Mechema Chemicals International grew its EBIT by 3.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mechema Chemicals International will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Mechema Chemicals International actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Mechema Chemicals International's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Overall, we don't think Mechema Chemicals International is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Mechema Chemicals International you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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