Is Tongtai Machine & Tool (TWSE:4526) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Tongtai Machine & Tool Co., Ltd. (TWSE:4526) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Tongtai Machine & Tool

How Much Debt Does Tongtai Machine & Tool Carry?

The image below, which you can click on for greater detail, shows that Tongtai Machine & Tool had debt of NT$4.01b at the end of June 2024, a reduction from NT$4.88b over a year. On the flip side, it has NT$931.0m in cash leading to net debt of about NT$3.08b.

How Strong Is Tongtai Machine & Tool's Balance Sheet?

According to the last reported balance sheet, Tongtai Machine & Tool had liabilities of NT$6.09b due within 12 months, and liabilities of NT$1.47b due beyond 12 months. Offsetting these obligations, it had cash of NT$931.0m as well as receivables valued at NT$2.50b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$4.13b.

While this might seem like a lot, it is not so bad since Tongtai Machine & Tool has a market capitalization of NT$8.96b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tongtai Machine & Tool's earnings that will influence how the balance sheet holds up in the future. 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.

Over 12 months, Tongtai Machine & Tool made a loss at the EBIT level, and saw its revenue drop to NT$6.6b, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

Not only did Tongtai Machine & Tool's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$527m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of NT$174m. In the meantime, we consider the stock very risky. 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. We've identified 2 warning signs with Tongtai Machine & Tool , and understanding them should be part of your investment process.

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.