Ta Ya Electric Wire & Cable (TPE:1609) Takes On Some Risk With Its Use Of 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.' 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 can see that Ta Ya Electric Wire & Cable (TPE:1609) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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

What Is Ta Ya Electric Wire & Cable's Debt?

As you can see below, at the end of December 2020, Ta Ya Electric Wire & Cable had NT$13.5b of debt, up from NT$10.2b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$3.86b, its net debt is less, at about NT$9.67b.

How Strong Is Ta Ya Electric Wire & Cable's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ta Ya Electric Wire & Cable had liabilities of NT$8.04b due within 12 months and liabilities of NT$8.04b due beyond that. Offsetting this, it had NT$3.86b in cash and NT$3.71b in receivables that were due within 12 months. So its liabilities total NT$8.51b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of NT$11.5b, so it does suggest shareholders should keep an eye on Ta Ya Electric Wire & Cable's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 12.7, it's fair to say Ta Ya Electric Wire & Cable does have a significant amount of debt. However, its interest coverage of 5.6 is reasonably strong, which is a good sign. Importantly, Ta Ya Electric Wire & Cable grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Ta Ya Electric 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.

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. During the last three years, Ta Ya Electric Wire & Cable burned a lot of cash. 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 net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Ta Ya Electric Wire & Cable stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Ta Ya Electric Wire & Cable (of which 1 is concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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