We Think Dah San Electric Wire & Cable (TPE:1615) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Dah San Electric Wire & Cable Corp. (TPE:1615) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Dah San Electric Wire & Cable

What Is Dah San Electric Wire & Cable's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Dah San Electric Wire & Cable had debt of NT$1.15b, up from NT$656.5m in one year. However, it also had NT$194.8m in cash, and so its net debt is NT$960.0m.

How Healthy Is Dah San Electric Wire & Cable's Balance Sheet?

We can see from the most recent balance sheet that Dah San Electric Wire & Cable had liabilities of NT$924.5m falling due within a year, and liabilities of NT$462.9m due beyond that. Offsetting this, it had NT$194.8m in cash and NT$525.0m in receivables that were due within 12 months. So it has liabilities totalling NT$667.6m more than its cash and near-term receivables, combined.

Dah San Electric Wire & Cable has a market capitalization of NT$2.88b, 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Dah San Electric Wire & Cable's moderate net debt to EBITDA ratio ( being 2.3), indicates prudence when it comes to debt. And its strong interest cover of 1k times, makes us even more comfortable. Importantly, Dah San Electric Wire & Cable grew its EBIT by 73% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dah San Electric Wire & Cable's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dah San Electric Wire & Cable burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Dah San Electric Wire & Cable's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. When we consider all the elements mentioned above, it seems to us that Dah San Electric Wire & Cable is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Dah San Electric Wire & Cable you should be aware of, and 2 of them are concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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