Is GlobalWafers (GTSM:6488) 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. Importantly, GlobalWafers Co., Ltd. (GTSM:6488) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for GlobalWafers

What Is GlobalWafers's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 GlobalWafers had NT$12.9b of debt, an increase on NT$10.7b, over one year. But on the other hand it also has NT$32.3b in cash, leading to a NT$19.4b net cash position.

How Strong Is GlobalWafers' Balance Sheet?

According to the last reported balance sheet, GlobalWafers had liabilities of NT$28.9b due within 12 months, and liabilities of NT$20.9b due beyond 12 months. On the other hand, it had cash of NT$32.3b and NT$8.31b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$9.16b.

Of course, GlobalWafers has a titanic market capitalization of NT$310.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, GlobalWafers boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that GlobalWafers has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if GlobalWafers can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GlobalWafers 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, GlobalWafers actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that GlobalWafers has NT$19.4b in net cash. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in NT$6.2b. So we don't have any problem with GlobalWafers's use of debt. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for GlobalWafers (of which 1 can't be ignored!) you should know about.

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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