Jiin Ming Industry (GTSM:3230) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Jiin Ming Industry Co., Ltd. (GTSM:3230) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Jiin Ming Industry

How Much Debt Does Jiin Ming Industry Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Jiin Ming Industry had debt of NT$234.9m, up from NT$204.2m in one year. However, it does have NT$130.2m in cash offsetting this, leading to net debt of about NT$104.8m.

A Look At Jiin Ming Industry's Liabilities

According to the last reported balance sheet, Jiin Ming Industry had liabilities of NT$478.1m due within 12 months, and liabilities of NT$111.0m due beyond 12 months. Offsetting this, it had NT$130.2m in cash and NT$525.0m in receivables that were due within 12 months. So it actually has NT$66.1m more liquid assets than total liabilities.

This surplus suggests that Jiin Ming Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While Jiin Ming Industry's low debt to EBITDA ratio of 0.75 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 4.5 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Notably, Jiin Ming Industry made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$45m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jiin Ming Industry 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Jiin Ming Industry burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Jiin Ming Industry's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to handle its debt, based on its EBITDA, is pretty flash. When we consider all the factors mentioned above, we do feel a bit cautious about Jiin Ming Industry's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Be aware that Jiin Ming Industry is showing 1 warning sign in our investment analysis , you should know about...

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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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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