Is Chuang Yi Biotech (GTSM:6566) 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.' 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 Chuang Yi Biotech co., ltd. (GTSM:6566) makes use of debt. But the real question is whether this debt is making the company risky.

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. 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 Chuang Yi Biotech

What Is Chuang Yi Biotech's Debt?

As you can see below, at the end of June 2020, Chuang Yi Biotech had NT$155.5m of debt, up from NT$81.0m a year ago. Click the image for more detail. However, it also had NT$55.0m in cash, and so its net debt is NT$100.5m.

How Healthy Is Chuang Yi Biotech's Balance Sheet?

We can see from the most recent balance sheet that Chuang Yi Biotech had liabilities of NT$185.9m falling due within a year, and liabilities of NT$20.3m due beyond that. Offsetting this, it had NT$55.0m in cash and NT$135.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$15.9m.

Of course, Chuang Yi Biotech has a market capitalization of NT$466.6m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Chuang Yi Biotech will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Chuang Yi Biotech had a loss before interest and tax, and actually shrunk its revenue by 93%, to NT$23m. That makes us nervous, to say the least.

Caveat Emptor

Not only did Chuang Yi Biotech's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping NT$192m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through NT$199m of cash over the last year. So in short it's a really risky stock. 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. To that end, you should learn about the 6 warning signs we've spotted with Chuang Yi Biotech (including 3 which make us uncomfortable) .

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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