Is TECO Electric & Machinery (TWSE:1504) 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.' 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. As with many other companies TECO Electric & Machinery Co., Ltd. (TWSE:1504) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for TECO Electric & Machinery

What Is TECO Electric & Machinery's Net Debt?

As you can see below, TECO Electric & Machinery had NT$9.91b of debt at December 2023, down from NT$10.4b a year prior. But on the other hand it also has NT$24.0b in cash, leading to a NT$14.1b net cash position.

A Look At TECO Electric & Machinery's Liabilities

According to the last reported balance sheet, TECO Electric & Machinery had liabilities of NT$22.6b due within 12 months, and liabilities of NT$18.2b due beyond 12 months. Offsetting this, it had NT$24.0b in cash and NT$15.8b in receivables that were due within 12 months. So its liabilities total NT$1.04b more than the combination of its cash and short-term receivables.

This state of affairs indicates that TECO Electric & Machinery's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the NT$120.4b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, TECO Electric & Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, TECO Electric & Machinery grew its EBIT by 31% 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 future earnings, more than anything, that will determine TECO Electric & Machinery's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While TECO Electric & Machinery has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, TECO Electric & Machinery produced sturdy free cash flow equating to 60% 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.

Summing Up

We could understand if investors are concerned about TECO Electric & Machinery's liabilities, but we can be reassured by the fact it has has net cash of NT$14.1b. And we liked the look of last year's 31% year-on-year EBIT growth. So is TECO Electric & Machinery's debt a risk? It doesn't seem so 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. For example - TECO Electric & Machinery has 1 warning sign we think you should be aware of.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.