Health Check: How Prudently Does Tung Ho Textile (TPE:1414) Use 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Tung Ho Textile Co., Ltd. (TPE:1414) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. 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.

See our latest analysis for Tung Ho Textile

How Much Debt Does Tung Ho Textile Carry?

The image below, which you can click on for greater detail, shows that Tung Ho Textile had debt of NT$497.4m at the end of December 2020, a reduction from NT$703.1m over a year. However, its balance sheet shows it holds NT$503.1m in cash, so it actually has NT$5.72m net cash.

A Look At Tung Ho Textile's Liabilities

According to the last reported balance sheet, Tung Ho Textile had liabilities of NT$597.5m due within 12 months, and liabilities of NT$699.2m due beyond 12 months. On the other hand, it had cash of NT$503.1m and NT$65.7m worth of receivables due within a year. So it has liabilities totalling NT$727.9m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Tung Ho Textile is worth NT$3.09b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Tung Ho Textile boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Tung Ho Textile will need earnings to service that debt. 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, Tung Ho Textile made a loss at the EBIT level, and saw its revenue drop to NT$702m, which is a fall of 11%. We would much prefer see growth.

So How Risky Is Tung Ho Textile?

Although Tung Ho Textile had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of NT$59m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. For riskier companies like Tung Ho Textile I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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