Health Check: How Prudently Does Skardin Industrial (GTSM:3466) Use Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Skardin Industrial Corporation (GTSM:3466) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Skardin Industrial

What Is Skardin Industrial's Debt?

As you can see below, Skardin Industrial had NT$149.5m of debt at September 2020, down from NT$213.9m a year prior. But it also has NT$565.7m in cash to offset that, meaning it has NT$416.2m net cash.

A Look At Skardin Industrial's Liabilities

According to the last reported balance sheet, Skardin Industrial had liabilities of NT$442.7m due within 12 months, and liabilities of NT$13.7m due beyond 12 months. Offsetting these obligations, it had cash of NT$565.7m as well as receivables valued at NT$281.6m due within 12 months. So it actually has NT$390.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Skardin Industrial's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Skardin Industrial boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Skardin Industrial's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Skardin Industrial had a loss before interest and tax, and actually shrunk its revenue by 50%, to NT$1.2b. That makes us nervous, to say the least.

So How Risky Is Skardin Industrial?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Skardin Industrial lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of NT$89m and booked a NT$133m accounting loss. Given it only has net cash of NT$416.2m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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 Skardin Industrial .

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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