Is Taiwan Line Tek Electronic (TPE:2462) Using Too Much 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Taiwan Line Tek Electronic Co., Ltd. (TPE:2462) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 Taiwan Line Tek Electronic

What Is Taiwan Line Tek Electronic's Debt?

You can click the graphic below for the historical numbers, but it shows that Taiwan Line Tek Electronic had NT$898.5m of debt in September 2020, down from NT$948.3m, one year before. On the flip side, it has NT$440.4m in cash leading to net debt of about NT$458.0m.

How Healthy Is Taiwan Line Tek Electronic's Balance Sheet?

According to the last reported balance sheet, Taiwan Line Tek Electronic had liabilities of NT$2.01b due within 12 months, and liabilities of NT$251.8m due beyond 12 months. Offsetting these obligations, it had cash of NT$440.4m as well as receivables valued at NT$1.86b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Taiwan Line Tek Electronic's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the NT$4.26b company is short on cash, but still worth keeping an eye on the balance sheet.

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.

Taiwan Line Tek Electronic's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its strong interest cover of 1k times, makes us even more comfortable. Importantly, Taiwan Line Tek Electronic grew its EBIT by 95% 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 Taiwan Line Tek Electronic 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Taiwan Line Tek Electronic actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Taiwan Line Tek Electronic's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Considering this range of factors, it seems to us that Taiwan Line Tek Electronic is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Taiwan Line Tek Electronic (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

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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