Here's Why TTY Biopharm (GTSM:4105) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that TTY Biopharm Company Limited (GTSM:4105) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for TTY Biopharm

What Is TTY Biopharm's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 TTY Biopharm had debt of NT$2.14b, up from NT$1.93b in one year. But on the other hand it also has NT$2.57b in cash, leading to a NT$422.5m net cash position.

How Strong Is TTY Biopharm's Balance Sheet?

We can see from the most recent balance sheet that TTY Biopharm had liabilities of NT$2.55b falling due within a year, and liabilities of NT$734.1m due beyond that. On the other hand, it had cash of NT$2.57b and NT$1.05b worth of receivables due within a year. So it actually has NT$333.1m more liquid assets than total liabilities.

Having regard to TTY Biopharm's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$18.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that TTY Biopharm has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for TTY Biopharm if management cannot prevent a repeat of the 22% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine TTY Biopharm'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While TTY Biopharm 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 most recent three years, TTY Biopharm recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case TTY Biopharm has NT$422.5m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 76% of that EBIT to free cash flow, bringing in NT$344m. So we don't have any problem with TTY Biopharm's use of debt. There's no doubt that we learn most about debt from the balance sheet. 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 TTY Biopharm .

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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