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

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.' 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 note that Taiwan Aries Co.,Ltd. (GTSM:6171) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Taiwan AriesLtd

What Is Taiwan AriesLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Taiwan AriesLtd had debt of NT$1.10b, up from NT$507.4m in one year. On the flip side, it has NT$151.4m in cash leading to net debt of about NT$951.3m.

How Healthy Is Taiwan AriesLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Taiwan AriesLtd had liabilities of NT$2.40b due within 12 months and no liabilities due beyond that. Offsetting this, it had NT$151.4m in cash and NT$1.22m in receivables that were due within 12 months. So its liabilities total NT$2.25b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$1.81b, we think shareholders really should watch Taiwan AriesLtd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Taiwan AriesLtd'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 Taiwan AriesLtd had a loss before interest and tax, and actually shrunk its revenue by 83%, to NT$34m. 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. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NT$489m over the last twelve months. So suffice it to say we consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Taiwan AriesLtd has 4 warning signs (and 2 which are a bit concerning) we think 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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