Is Thong Guan Industries Berhad (KLSE:TGUAN) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Thong Guan Industries Berhad (KLSE:TGUAN) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Thong Guan Industries Berhad

What Is Thong Guan Industries Berhad's Debt?

As you can see below, Thong Guan Industries Berhad had RM137.3m of debt at September 2020, down from RM155.1m a year prior. But it also has RM258.8m in cash to offset that, meaning it has RM121.5m net cash.

How Healthy Is Thong Guan Industries Berhad's Balance Sheet?

According to the last reported balance sheet, Thong Guan Industries Berhad had liabilities of RM185.2m due within 12 months, and liabilities of RM71.5m due beyond 12 months. Offsetting this, it had RM258.8m in cash and RM208.1m in receivables that were due within 12 months. So it can boast RM210.3m more liquid assets than total liabilities.

This excess liquidity suggests that Thong Guan Industries Berhad is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Thong Guan Industries Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Thong Guan Industries Berhad grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Thong Guan Industries Berhad's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Thong Guan Industries Berhad 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. Looking at the most recent three years, Thong Guan Industries Berhad recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Thong Guan Industries Berhad has RM121.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 23% over the last year. So we don't think Thong Guan Industries Berhad's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Thong Guan Industries Berhad has 3 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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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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