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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Lifestyle Global Enterprise Inc. (GTSM:8066) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Lifestyle Global Enterprise Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Lifestyle Global Enterprise had debt of NT$674.4m, up from NT$494.4m in one year. However, it also had NT$630.9m in cash, and so its net debt is NT$43.6m.
A Look At Lifestyle Global Enterprise’s Liabilities
Zooming in on the latest balance sheet data, we can see that Lifestyle Global Enterprise had liabilities of NT$1.09b due within 12 months and liabilities of NT$406.4m due beyond that. Offsetting this, it had NT$630.9m in cash and NT$1.23b in receivables that were due within 12 months. So it can boast NT$366.6m more liquid assets than total liabilities.
This surplus suggests that Lifestyle Global Enterprise is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don’t think it will have any issues with its lenders.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Lifestyle Global Enterprise’s net debt is only 0.19 times its EBITDA. And its EBIT easily covers its interest expense, being 15.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Lifestyle Global Enterprise if management cannot prevent a repeat of the 49% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since Lifestyle Global Enterprise 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Lifestyle Global Enterprise recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Happily, Lifestyle Global Enterprise’s impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its EBIT growth rate. Taking all this data into account, it seems to us that Lifestyle Global Enterprise takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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 5 warning signs we’ve spotted with Lifestyle Global Enterprise (including 1 which is significant) .
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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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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