These 4 Measures Indicate That Gloria Material Technology (GTSM:5009) Is Using Debt In A Risky Way

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Gloria Material Technology Corp. (GTSM:5009) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Gloria Material Technology

What Is Gloria Material Technology's Debt?

As you can see below, Gloria Material Technology had NT$10.3b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$926.8m in cash leading to net debt of about NT$9.38b.

How Strong Is Gloria Material Technology's Balance Sheet?

The latest balance sheet data shows that Gloria Material Technology had liabilities of NT$2.96b due within a year, and liabilities of NT$8.63b falling due after that. Offsetting these obligations, it had cash of NT$926.8m as well as receivables valued at NT$1.65b due within 12 months. So its liabilities total NT$9.01b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's NT$6.27b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Gloria Material Technology shareholders face the double whammy of a high net debt to EBITDA ratio (11.7), and fairly weak interest coverage, since EBIT is just 1.1 times the interest expense. The debt burden here is substantial. Even worse, Gloria Material Technology saw its EBIT tank 68% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Gloria Material Technology can strengthen its balance sheet over time. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Gloria Material Technology 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

To be frank both Gloria Material Technology's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its net debt to EBITDA also fails to instill confidence. Considering everything we've mentioned above, it's fair to say that Gloria Material Technology is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. Case in point: We've spotted 3 warning signs for Gloria Material Technology you should be aware of, and 1 of them can't be ignored.

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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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.
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