Is Run Long Construction (TWSE:1808) Using Too Much Debt?

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 note that Run Long Construction Co., Ltd. (TWSE:1808) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Run Long Construction

What Is Run Long Construction's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Run Long Construction had NT$20.9b of debt in December 2023, down from NT$33.6b, one year before. On the flip side, it has NT$4.32b in cash leading to net debt of about NT$16.6b.

A Look At Run Long Construction's Liabilities

The latest balance sheet data shows that Run Long Construction had liabilities of NT$24.7b due within a year, and liabilities of NT$4.31b falling due after that. Offsetting these obligations, it had cash of NT$4.32b as well as receivables valued at NT$756.8m due within 12 months. So it has liabilities totalling NT$24.0b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Run Long Construction has a market capitalization of NT$49.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Run Long Construction's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 56.6 times, makes us even more comfortable. Notably, Run Long Construction's EBIT launched higher than Elon Musk, gaining a whopping 4,217% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Run Long Construction will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Run Long Construction recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

The good news is that Run Long Construction's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Looking at the bigger picture, we think Run Long Construction's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Run Long Construction .

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.