Is Tong Yang IndustryLtd (TPE:1319) Using Too Much Debt?

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. We can see that Tong Yang Industry Co.,Ltd. (TPE:1319) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Tong Yang IndustryLtd

What Is Tong Yang IndustryLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Tong Yang IndustryLtd had NT$7.85b of debt in December 2020, down from NT$8.67b, one year before. However, because it has a cash reserve of NT$1.56b, its net debt is less, at about NT$6.28b.

A Look At Tong Yang IndustryLtd's Liabilities

We can see from the most recent balance sheet that Tong Yang IndustryLtd had liabilities of NT$6.38b falling due within a year, and liabilities of NT$6.81b due beyond that. On the other hand, it had cash of NT$1.56b and NT$3.58b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$8.05b.

While this might seem like a lot, it is not so bad since Tong Yang IndustryLtd has a market capitalization of NT$22.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Tong Yang IndustryLtd's net debt is sitting at a very reasonable 1.7 times its EBITDA, while its EBIT covered its interest expense just 4.4 times last year. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. Importantly, Tong Yang IndustryLtd's EBIT fell a jaw-dropping 75% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tong Yang IndustryLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Tong Yang IndustryLtd recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Tong Yang IndustryLtd's EBIT growth rate and interest cover definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Tong Yang IndustryLtd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tong Yang IndustryLtd is showing 2 warning signs in our investment analysis , you should know about...

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.

When trading Tong Yang IndustryLtd or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.