Is Chip Hope (GTSM:8084) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Chip Hope Co., Ltd (GTSM:8084) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chip Hope

What Is Chip Hope's Debt?

The image below, which you can click on for greater detail, shows that Chip Hope had debt of NT$410.6m at the end of December 2020, a reduction from NT$601.8m over a year. On the flip side, it has NT$155.4m in cash leading to net debt of about NT$255.2m.

How Healthy Is Chip Hope's Balance Sheet?

The latest balance sheet data shows that Chip Hope had liabilities of NT$453.8m due within a year, and liabilities of NT$205.2m falling due after that. On the other hand, it had cash of NT$155.4m and NT$205.3m worth of receivables due within a year. So it has liabilities totalling NT$298.3m more than its cash and near-term receivables, combined.

Since publicly traded Chip Hope shares are worth a total of NT$5.73b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chip Hope 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 Chip Hope had a loss before interest and tax, and actually shrunk its revenue by 50%, to NT$1.0b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Chip Hope's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$182m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of NT$172m into a profit. So to be blunt we do think it is risky. 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. Case in point: We've spotted 2 warning signs for Chip Hope you should be aware of, and 1 of them is concerning.

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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