Is Gamania Digital Entertainment (GTSM:6180) Using Too Much Debt?

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.' 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 Gamania Digital Entertainment Co., Ltd. (GTSM:6180) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Gamania Digital Entertainment

How Much Debt Does Gamania Digital Entertainment Carry?

The image below, which you can click on for greater detail, shows that Gamania Digital Entertainment had debt of NT$917.2m at the end of September 2020, a reduction from NT$1.40b over a year. But on the other hand it also has NT$2.24b in cash, leading to a NT$1.33b net cash position.

How Healthy Is Gamania Digital Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gamania Digital Entertainment had liabilities of NT$3.87b due within 12 months and liabilities of NT$226.5m due beyond that. Offsetting this, it had NT$2.24b in cash and NT$1.57b in receivables that were due within 12 months. So its liabilities total NT$275.9m more than the combination of its cash and short-term receivables.

Since publicly traded Gamania Digital Entertainment shares are worth a total of NT$11.8b, 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. Despite its noteworthy liabilities, Gamania Digital Entertainment boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Gamania Digital Entertainment grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Gamania Digital Entertainment's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gamania Digital Entertainment has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Gamania Digital Entertainment recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Gamania Digital Entertainment's liabilities, but we can be reassured by the fact it has has net cash of NT$1.33b. And it impressed us with free cash flow of NT$1.2b, being 85% of its EBIT. So is Gamania Digital Entertainment's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Gamania Digital Entertainment that you should be aware of.

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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