Shuang-Bang Industrial (GTSM:6506) Has A Somewhat Strained Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Shuang-Bang Industrial Corp. (GTSM:6506) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shuang-Bang Industrial

What Is Shuang-Bang Industrial's Net Debt?

The image below, which you can click on for greater detail, shows that Shuang-Bang Industrial had debt of NT$751.3m at the end of September 2020, a reduction from NT$815.8m over a year. However, because it has a cash reserve of NT$144.3m, its net debt is less, at about NT$607.0m.

A Look At Shuang-Bang Industrial's Liabilities

According to the last reported balance sheet, Shuang-Bang Industrial had liabilities of NT$472.2m due within 12 months, and liabilities of NT$627.4m due beyond 12 months. Offsetting these obligations, it had cash of NT$144.3m as well as receivables valued at NT$295.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$659.8m.

While this might seem like a lot, it is not so bad since Shuang-Bang Industrial has a market capitalization of NT$1.31b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Shuang-Bang Industrial has a debt to EBITDA ratio of 3.8 and its EBIT covered its interest expense 6.1 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Shuang-Bang Industrial's EBIT fell a jaw-dropping 44% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Shuang-Bang Industrial will need earnings to service that debt. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Shuang-Bang Industrial 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 Shuang-Bang Industrial'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. But at least its interest cover is not so bad. Overall, it seems to us that Shuang-Bang Industrial's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Shuang-Bang Industrial (including 1 which is can't be ignored) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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