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.' 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 Loyalty Founder Enterprise Co.,Ltd. (GTSM:5465) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Loyalty Founder EnterpriseLtd
What Is Loyalty Founder EnterpriseLtd's Debt?
As you can see below, at the end of September 2020, Loyalty Founder EnterpriseLtd had NT$250.0m of debt, up from NT$170.0m a year ago. Click the image for more detail. However, it does have NT$1.09b in cash offsetting this, leading to net cash of NT$836.6m.
How Healthy Is Loyalty Founder EnterpriseLtd's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Loyalty Founder EnterpriseLtd had liabilities of NT$2.84b due within 12 months and liabilities of NT$51.2m due beyond that. Offsetting these obligations, it had cash of NT$1.09b as well as receivables valued at NT$1.95b due within 12 months. So it actually has NT$145.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Loyalty Founder EnterpriseLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Loyalty Founder EnterpriseLtd boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, Loyalty Founder EnterpriseLtd grew its EBIT by 355% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Loyalty Founder EnterpriseLtd'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Loyalty Founder EnterpriseLtd 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. During the last three years, Loyalty Founder EnterpriseLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing up
While it is always sensible to investigate a company's debt, in this case Loyalty Founder EnterpriseLtd has NT$836.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 355% over the last year. So we don't have any problem with Loyalty Founder EnterpriseLtd'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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for Loyalty Founder EnterpriseLtd you should know about.
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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About TPEX:5465
Loyalty Founder EnterpriseLtd
Engages in the manufacture, processing, and sale of precision steel molds and stamping die products for computers and server chassis in Taiwan, the United States, and Mainland China.
Flawless balance sheet established dividend payer.
