Does Pontex PolyblendLtd (GTSM:8935) Have A Healthy Balance Sheet?

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. We note that Pontex Polyblend Co.,Ltd (GTSM:8935) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pontex PolyblendLtd

What Is Pontex PolyblendLtd's Debt?

As you can see below, at the end of September 2020, Pontex PolyblendLtd had NT$823.4m of debt, up from NT$676.5m a year ago. Click the image for more detail. On the flip side, it has NT$149.7m in cash leading to net debt of about NT$673.6m.

How Strong Is Pontex PolyblendLtd's Balance Sheet?

We can see from the most recent balance sheet that Pontex PolyblendLtd had liabilities of NT$516.3m falling due within a year, and liabilities of NT$489.1m due beyond that. Offsetting this, it had NT$149.7m in cash and NT$312.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$543.1m.

This is a mountain of leverage relative to its market capitalization of NT$673.6m. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.50 times and a disturbingly high net debt to EBITDA ratio of 11.0 hit our confidence in Pontex PolyblendLtd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for Pontex PolyblendLtd is that it turned last year's EBIT loss into a gain of NT$10.0m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Pontex PolyblendLtd'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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Pontex PolyblendLtd 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 Pontex PolyblendLtd's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider Pontex PolyblendLtd to be really rather risky, as a result of its balance sheet health. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Pontex PolyblendLtd .

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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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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