Is Hua Eng Wire & Cable (TPE:1608) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Hua Eng Wire & Cable Co., Ltd. (TPE:1608) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hua Eng Wire & Cable

What Is Hua Eng Wire & Cable's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Hua Eng Wire & Cable had NT$2.77b of debt, an increase on NT$2.38b, over one year. However, it does have NT$1.24b in cash offsetting this, leading to net debt of about NT$1.52b.

A Look At Hua Eng Wire & Cable's Liabilities

According to the last reported balance sheet, Hua Eng Wire & Cable had liabilities of NT$3.32b due within 12 months, and liabilities of NT$1.04b due beyond 12 months. Offsetting this, it had NT$1.24b in cash and NT$1.18b in receivables that were due within 12 months. So it has liabilities totalling NT$1.93b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hua Eng Wire & Cable has a market capitalization of NT$5.62b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely Hua Eng Wire & Cable has a sky high EBITDA ratio of 7.1, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. We also note that Hua Eng Wire & Cable improved its EBIT from a last year's loss to a positive NT$71m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hua Eng Wire & Cable 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Hua Eng Wire & Cable actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Based on what we've seen Hua Eng Wire & Cable is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Considering this range of data points, we think Hua Eng Wire & Cable is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For instance, we've identified 2 warning signs for Hua Eng Wire & Cable that you should be aware of.

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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