Does Taiwan Secom (TPE:9917) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Taiwan Secom Co., Ltd. (TPE:9917) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Taiwan Secom

What Is Taiwan Secom's Net Debt?

As you can see below, at the end of September 2020, Taiwan Secom had NT$4.08b of debt, up from NT$3.78b a year ago. Click the image for more detail. But it also has NT$5.25b in cash to offset that, meaning it has NT$1.16b net cash.

How Healthy Is Taiwan Secom's Balance Sheet?

We can see from the most recent balance sheet that Taiwan Secom had liabilities of NT$8.31b falling due within a year, and liabilities of NT$2.92b due beyond that. On the other hand, it had cash of NT$5.25b and NT$1.42b worth of receivables due within a year. So its liabilities total NT$4.56b more than the combination of its cash and short-term receivables.

Since publicly traded Taiwan Secom shares are worth a total of NT$38.1b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Taiwan Secom also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Taiwan Secom saw its EBIT decline by 2.5% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Taiwan Secom's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Taiwan Secom may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Taiwan Secom recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Taiwan Secom's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$1.16b. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in NT$1.5b. So we don't think Taiwan Secom's use of debt is risky. Given Taiwan Secom has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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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