Does Ruentex Engineering & Construction (TPE:2597) Have A Healthy Balance Sheet?

Warren Buffett famously said, '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. Importantly, Ruentex Engineering & Construction Co., Ltd. (TPE:2597) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Ruentex Engineering & Construction

What Is Ruentex Engineering & Construction's Net Debt?

As you can see below, Ruentex Engineering & Construction had NT$2.20b of debt at December 2020, down from NT$2.49b a year prior. On the flip side, it has NT$883.7m in cash leading to net debt of about NT$1.32b.

A Look At Ruentex Engineering & Construction's Liabilities

We can see from the most recent balance sheet that Ruentex Engineering & Construction had liabilities of NT$4.37b falling due within a year, and liabilities of NT$1.97b due beyond that. On the other hand, it had cash of NT$883.7m and NT$3.94b worth of receivables due within a year. So its liabilities total NT$1.52b more than the combination of its cash and short-term receivables.

Given Ruentex Engineering & Construction has a market capitalization of NT$12.1b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ruentex Engineering & Construction has a low net debt to EBITDA ratio of only 0.93. And its EBIT easily covers its interest expense, being 3k times the size. So we're pretty relaxed about its super-conservative use of debt. On top of that, Ruentex Engineering & Construction grew its EBIT by 61% 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 Ruentex Engineering & Construction'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Ruentex Engineering & Construction produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Ruentex Engineering & Construction's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Ruentex Engineering & Construction's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Ruentex Engineering & Construction is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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