Is Tongtai Machine & Tool (TPE:4526) Using Debt In A Risky Way?

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.' 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 Tongtai Machine & Tool Co., Ltd. (TPE:4526) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Tongtai Machine & Tool

What Is Tongtai Machine & Tool's Debt?

The chart below, which you can click on for greater detail, shows that Tongtai Machine & Tool had NT$6.68b in debt in September 2020; about the same as the year before. However, it also had NT$1.63b in cash, and so its net debt is NT$5.05b.

A Look At Tongtai Machine & Tool's Liabilities

We can see from the most recent balance sheet that Tongtai Machine & Tool had liabilities of NT$8.97b falling due within a year, and liabilities of NT$2.07b due beyond that. On the other hand, it had cash of NT$1.63b and NT$3.82b worth of receivables due within a year. So its liabilities total NT$5.59b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$3.67b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Tongtai Machine & Tool would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tongtai Machine & Tool 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.

In the last year Tongtai Machine & Tool had a loss before interest and tax, and actually shrunk its revenue by 24%, to NT$8.6b. That makes us nervous, to say the least.

Caveat Emptor

While Tongtai Machine & Tool's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost NT$242m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of NT$159m. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Tongtai Machine & Tool you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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