Tong Yang IndustryLtd (TPE:1319) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Tong Yang Industry Co.,Ltd. (TPE:1319) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tong Yang IndustryLtd

What Is Tong Yang IndustryLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Tong Yang IndustryLtd had debt of NT$8.25b at the end of September 2020, a reduction from NT$9.56b over a year. However, because it has a cash reserve of NT$1.53b, its net debt is less, at about NT$6.72b.

How Healthy Is Tong Yang IndustryLtd's Balance Sheet?

The latest balance sheet data shows that Tong Yang IndustryLtd had liabilities of NT$7.11b due within a year, and liabilities of NT$6.30b falling due after that. On the other hand, it had cash of NT$1.53b and NT$3.52b worth of receivables due within a year. So its liabilities total NT$8.36b more than the combination of its cash and short-term receivables.

Tong Yang IndustryLtd has a market capitalization of NT$23.1b, so it could very likely raise cash to ameliorate 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a debt to EBITDA ratio of 1.6, Tong Yang IndustryLtd uses debt artfully but responsibly. And the alluring interest cover (EBIT of 7.3 times interest expense) certainly does not do anything to dispel this impression. It is just as well that Tong Yang IndustryLtd's load is not too heavy, because its EBIT was down 52% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tong Yang IndustryLtd can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Tong Yang IndustryLtd generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Tong Yang IndustryLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Tong Yang IndustryLtd's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Tong Yang IndustryLtd you should know about.

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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