Femco Steel Technology (GTSM:6731) Has Debt But No Earnings; Should You Worry?

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.' 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. We can see that Femco Steel Technology Co., Ltd. (GTSM:6731) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Femco Steel Technology

What Is Femco Steel Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Femco Steel Technology had NT$202.0m of debt, an increase on NT$133.2m, over one year. But it also has NT$222.4m in cash to offset that, meaning it has NT$20.4m net cash.

A Look At Femco Steel Technology's Liabilities

The latest balance sheet data shows that Femco Steel Technology had liabilities of NT$314.8m due within a year, and liabilities of NT$77.8m falling due after that. Offsetting these obligations, it had cash of NT$222.4m as well as receivables valued at NT$96.5m due within 12 months. So it has liabilities totalling NT$73.7m more than its cash and near-term receivables, combined.

Since publicly traded Femco Steel Technology shares are worth a total of NT$947.0m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Femco Steel Technology also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Femco Steel Technology'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.

Over 12 months, Femco Steel Technology reported revenue of NT$636m, which is a gain of 2.9%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Femco Steel Technology?

Although Femco Steel Technology had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of NT$2.2m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. For instance, we've identified 2 warning signs for Femco Steel Technology (1 shouldn't be ignored) you should be aware of.

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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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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