Yung Zip Chemical Ind (GTSM:4102) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. As with many other companies Yung Zip Chemical Ind. Co., Ltd. (GTSM:4102) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Yung Zip Chemical Ind

What Is Yung Zip Chemical Ind's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Yung Zip Chemical Ind had NT$267.9m of debt, an increase on NT$75.0m, over one year. However, it also had NT$44.6m in cash, and so its net debt is NT$223.3m.

How Healthy Is Yung Zip Chemical Ind's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yung Zip Chemical Ind had liabilities of NT$167.7m due within 12 months and liabilities of NT$216.8m due beyond that. Offsetting these obligations, it had cash of NT$44.6m as well as receivables valued at NT$116.9m due within 12 months. So it has liabilities totalling NT$223.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Yung Zip Chemical Ind has a market capitalization of NT$1.09b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Yung Zip Chemical Ind has a debt to EBITDA ratio of 3.5, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 27.5 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Notably, Yung Zip Chemical Ind's EBIT launched higher than Elon Musk, gaining a whopping 116% on last year. 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 Yung Zip Chemical Ind can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last two years, Yung Zip Chemical Ind's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Happily, Yung Zip Chemical Ind's impressive interest cover implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. All these things considered, it appears that Yung Zip Chemical Ind can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Case in point: We've spotted 2 warning signs for Yung Zip Chemical Ind you should be aware of, and 1 of them is concerning.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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