Loyalty Founder EnterpriseLtd (GTSM:5465) Has A Pretty Healthy Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Loyalty Founder Enterprise Co.,Ltd. (GTSM:5465) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

How Much Debt Does Loyalty Founder EnterpriseLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Loyalty Founder EnterpriseLtd had debt of NT$250.0m, up from NT$170.0m in one year. But it also has NT$1.09b in cash to offset that, meaning it has NT$836.6m net cash.

How Healthy Is Loyalty Founder EnterpriseLtd's Balance Sheet?

According to the last reported balance sheet, Loyalty Founder EnterpriseLtd had liabilities of NT$2.84b due within 12 months, and liabilities of NT$51.2m due beyond 12 months. Offsetting this, it had NT$1.09b in cash and NT$1.95b in receivables that were due within 12 months. So it can boast 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. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Loyalty Founder EnterpriseLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, Loyalty Founder EnterpriseLtd saw substantial negative free cash flow, in total. 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.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Loyalty Founder EnterpriseLtd has net cash of NT$836.6m, as well as more liquid assets than liabilities. 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. 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. Be aware that Loyalty Founder EnterpriseLtd is showing 1 warning sign in our investment analysis , you should know about...

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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