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.' 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. As with many other companies Cipherlab Co.,Ltd. (GTSM:6160) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CipherlabLtd's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 CipherlabLtd had NT$152.0m of debt, an increase on NT$100.0m, over one year. However, because it has a cash reserve of NT$127.1m, its net debt is less, at about NT$24.9m.
A Look At CipherlabLtd's Liabilities
We can see from the most recent balance sheet that CipherlabLtd had liabilities of NT$293.3m falling due within a year, and liabilities of NT$68.0m due beyond that. On the other hand, it had cash of NT$127.1m and NT$226.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.43m.
This state of affairs indicates that CipherlabLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$941.7m company is struggling for cash, we still think it's worth monitoring its balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since CipherlabLtd 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.
In the last year CipherlabLtd had a loss before interest and tax, and actually shrunk its revenue by 28%, to NT$1.0b. To be frank that doesn't bode well.
While CipherlabLtd'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$108m 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. However, it doesn't help that it burned through NT$98m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with CipherlabLtd (including 1 which shouldn't be ignored) .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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