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. As with many other companies Ta Ya Electric Wire & Cable (TPE:1609) makes use of debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Ta Ya Electric Wire & Cable
How Much Debt Does Ta Ya Electric Wire & Cable Carry?
As you can see below, at the end of September 2020, Ta Ya Electric Wire & Cable had NT$12.5b of debt, up from NT$10.5b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$3.79b, its net debt is less, at about NT$8.68b.
How Strong Is Ta Ya Electric Wire & Cable's Balance Sheet?
According to the last reported balance sheet, Ta Ya Electric Wire & Cable had liabilities of NT$8.55b due within 12 months, and liabilities of NT$6.26b due beyond 12 months. Offsetting this, it had NT$3.79b in cash and NT$3.07b in receivables that were due within 12 months. So it has liabilities totalling NT$7.96b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of NT$11.5b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
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 net debt to EBITDA ratio of 14.4, it's fair to say Ta Ya Electric Wire & Cable does have a significant amount of debt. However, its interest coverage of 2.6 is reasonably strong, which is a good sign. Even worse, Ta Ya Electric Wire & Cable saw its EBIT tank 30% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ta Ya Electric Wire & Cable's earnings that will influence how the balance sheet holds up in the future. 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. 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, Ta Ya Electric Wire & Cable saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
On the face of it, Ta Ya Electric Wire & Cable's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And even its interest cover fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Ta Ya Electric Wire & Cable has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. To that end, you should learn about the 2 warning signs we've spotted with Ta Ya Electric Wire & Cable (including 1 which is is a bit concerning) .
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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About TWSE:1609
Ta Ya Electric Wire & Cable
Engages in the manufacture and sale of electric wires and cables in Taiwan and rest of Asia.
Slight with mediocre balance sheet.