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, Grand Hall Enterprise Co., Ltd. (GTSM:8941) does carry debt. But the real question is whether this debt is making the company risky.
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Grand Hall Enterprise Carry?
The image below, which you can click on for greater detail, shows that at September 2020 Grand Hall Enterprise had debt of NT$112.0m, up from none in one year. But it also has NT$432.2m in cash to offset that, meaning it has NT$320.2m net cash.
A Look At Grand Hall Enterprise’s Liabilities
We can see from the most recent balance sheet that Grand Hall Enterprise had liabilities of NT$850.9m falling due within a year, and liabilities of NT$236.9m due beyond that. On the other hand, it had cash of NT$432.2m and NT$116.8m worth of receivables due within a year. So it has liabilities totalling NT$538.8m more than its cash and near-term receivables, combined.
Grand Hall Enterprise has a market capitalization of NT$1.17b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Grand Hall Enterprise also has more cash than debt, so we’re pretty confident it can manage its debt safely.
Even more impressive was the fact that Grand Hall Enterprise grew its EBIT by 197% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Grand Hall Enterprise 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Grand Hall Enterprise has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Grand Hall Enterprise actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While Grand Hall Enterprise does have more liabilities than liquid assets, it also has net cash of NT$320.2m. And it impressed us with free cash flow of NT$225m, being 448% of its EBIT. So is Grand Hall Enterprise’s debt a risk? It doesn’t seem so to us. 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. For example – Grand Hall Enterprise has 2 warning signs we think you should be aware of.
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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