These 4 Measures Indicate That Global Brands Manufacture (TPE:6191) Is Using Debt Reasonably Well

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, Global Brands Manufacture Ltd. (TPE:6191) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

Check out our latest analysis for Global Brands Manufacture

What Is Global Brands Manufacture's Net Debt?

As you can see below, Global Brands Manufacture had NT$8.80b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has NT$3.78b in cash leading to net debt of about NT$5.02b.

A Look At Global Brands Manufacture's Liabilities

Zooming in on the latest balance sheet data, we can see that Global Brands Manufacture had liabilities of NT$11.9b due within 12 months and liabilities of NT$4.32b due beyond that. Offsetting this, it had NT$3.78b in cash and NT$8.27b in receivables that were due within 12 months. So it has liabilities totalling NT$4.15b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Global Brands Manufacture is worth NT$13.7b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Global Brands Manufacture's moderate net debt to EBITDA ratio ( being 1.6), indicates prudence when it comes to debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. Better yet, Global Brands Manufacture grew its EBIT by 154% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Global Brands Manufacture can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Global Brands Manufacture recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Global Brands Manufacture's interest cover was a real positive on this analysis, as was its EBIT growth rate. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. When we consider all the elements mentioned above, it seems to us that Global Brands Manufacture is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Global Brands Manufacture .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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