TECO Electric & Machinery (TWSE:1504) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, TECO Electric & Machinery Co., Ltd. (TWSE:1504) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View 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$12.5b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has NT$24.9b in cash to offset that, meaning it has NT$12.4b net cash.

How Healthy Is TECO Electric & Machinery's Balance Sheet?

According to the last reported balance sheet, TECO Electric & Machinery had liabilities of NT$28.1b due within 12 months, and liabilities of NT$13.6b due beyond 12 months. Offsetting this, it had NT$24.9b in cash and NT$15.3b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.52b.

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 while it's hard to imagine that the NT$116.6b company is struggling for cash, we still think it's worth monitoring its 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!

TECO Electric & Machinery's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the most recent three years, TECO Electric & Machinery recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

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$12.4b. So we are not troubled with TECO Electric & Machinery's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for TECO Electric & Machinery you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.