Would Daito Me Holdings (GTSM:8455) Be Better Off With Less Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Daito Me Holdings Co., Ltd (GTSM:8455) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Daito Me Holdings

What Is Daito Me Holdings's Debt?

As you can see below, Daito Me Holdings had NT$599.9m of debt at September 2020, down from NT$668.6m a year prior. However, it does have NT$360.9m in cash offsetting this, leading to net debt of about NT$239.1m.

A Look At Daito Me Holdings' Liabilities

The latest balance sheet data shows that Daito Me Holdings had liabilities of NT$629.8m due within a year, and liabilities of NT$273.8m falling due after that. Offsetting this, it had NT$360.9m in cash and NT$426.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$116.2m.

Daito Me Holdings has a market capitalization of NT$455.2m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daito Me Holdings will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Daito Me Holdings had a loss before interest and tax, and actually shrunk its revenue by 44%, to NT$1.6b. That makes us nervous, to say the least.

Caveat Emptor

While Daito Me Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at NT$16m. 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. For example, we would not want to see a repeat of last year's loss of NT$6.0m. In the meantime, we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Daito Me Holdings (1 shouldn't be ignored!) that you should be aware of before investing here.

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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