CGS International (GTSM:5310) Is Making Moderate Use Of 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.' 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. We can see that CGS International Inc. (GTSM:5310) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for CGS International

What Is CGS International's Debt?

As you can see below, CGS International had NT$83.0m of debt at September 2020, down from NT$128.0m a year prior. On the flip side, it has NT$31.6m in cash leading to net debt of about NT$51.4m.

How Healthy Is CGS International's Balance Sheet?

We can see from the most recent balance sheet that CGS International had liabilities of NT$142.8m falling due within a year, and liabilities of NT$9.42m due beyond that. On the other hand, it had cash of NT$31.6m and NT$37.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$83.6m.

Since publicly traded CGS International shares are worth a total of NT$646.4m, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is CGS International'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 CGS International had a loss before interest and tax, and actually shrunk its revenue by 56%, to NT$173m. To be frank that doesn't bode well.

Caveat Emptor

While CGS International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable NT$91m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of NT$140m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with CGS International (including 1 which doesn't sit too well with us) .

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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