Is Taiwan AriesLtd (GTSM:6171) Using Debt In A Risky Way?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Taiwan Aries Co.,Ltd. (GTSM:6171) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Taiwan AriesLtd

What Is Taiwan AriesLtd's Debt?

As you can see below, at the end of September 2020, Taiwan AriesLtd had NT$1.10b of debt, up from NT$507.4m a year ago. Click the image for more detail. On the flip side, it has NT$151.4m in cash leading to net debt of about NT$951.3m.

How Strong Is Taiwan AriesLtd's Balance Sheet?

According to the balance sheet data, Taiwan AriesLtd had liabilities of NT$2.40b due within 12 months, but no longer term liabilities. On the other hand, it had cash of NT$151.4m and NT$1.22m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.25b.

Given this deficit is actually higher than the company's market capitalization of NT$1.79b, we think shareholders really should watch Taiwan AriesLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. 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 Taiwan AriesLtd 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.

Over 12 months, Taiwan AriesLtd made a loss at the EBIT level, and saw its revenue drop to NT$34m, which is a fall of 83%. To be frank that doesn't bode well.

Caveat Emptor

While Taiwan AriesLtd'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 NT$35m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through NT$489m in negative free cash flow over the last year. That means it's on the risky side of things. 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. Be aware that Taiwan AriesLtd is showing 4 warning signs in our investment analysis , and 2 of those are a bit concerning...

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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