We Think Te Chang Construction (GTSM:5511) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Te Chang Construction Co., Ltd. (GTSM:5511) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Te Chang Construction

What Is Te Chang Construction's Net Debt?

As you can see below, at the end of September 2020, Te Chang Construction had NT$926.0m of debt, up from NT$434.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$1.11b in cash, so it actually has NT$185.4m net cash.

How Healthy Is Te Chang Construction's Balance Sheet?

The latest balance sheet data shows that Te Chang Construction had liabilities of NT$4.50b due within a year, and liabilities of NT$230.4m falling due after that. On the other hand, it had cash of NT$1.11b and NT$3.33b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$291.7m.

Given Te Chang Construction has a market capitalization of NT$3.44b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Te Chang Construction also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Te Chang Construction's load is not too heavy, because its EBIT was down 45% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Te Chang Construction 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. While Te Chang Construction 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 three years, Te Chang Construction recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about Te Chang Construction's liabilities, but we can be reassured by the fact it has has net cash of NT$185.4m. And it impressed us with free cash flow of -NT$50m, being 86% of its EBIT. So we are not troubled with Te Chang Construction's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Te Chang Construction , and understanding them should be part of your investment process.

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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