Is Da-Cin ConstructionLtd (TPE:2535) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 Da-Cin Construction Co.,Ltd. (TPE:2535) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Da-Cin ConstructionLtd

What Is Da-Cin ConstructionLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Da-Cin ConstructionLtd had NT$2.66b of debt in September 2020, down from NT$2.82b, one year before. But on the other hand it also has NT$6.40b in cash, leading to a NT$3.74b net cash position.

How Healthy Is Da-Cin ConstructionLtd's Balance Sheet?

The latest balance sheet data shows that Da-Cin ConstructionLtd had liabilities of NT$9.26b due within a year, and liabilities of NT$1.67b falling due after that. Offsetting this, it had NT$6.40b in cash and NT$3.86b in receivables that were due within 12 months. So it has liabilities totalling NT$669.6m more than its cash and near-term receivables, combined.

Of course, Da-Cin ConstructionLtd has a market capitalization of NT$8.12b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Da-Cin ConstructionLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Da-Cin ConstructionLtd grew its EBIT by 53% 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 ultimately the future profitability of the business will decide if Da-Cin ConstructionLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Da-Cin ConstructionLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Da-Cin ConstructionLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Da-Cin ConstructionLtd has NT$3.74b in net cash. And it impressed us with free cash flow of NT$1.8b, being 120% of its EBIT. So we don't think Da-Cin ConstructionLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Da-Cin ConstructionLtd .

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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