Is Zeng Hsing Industrial (TPE:1558) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Zeng Hsing Industrial Co., Ltd. (TPE:1558) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Zeng Hsing Industrial

How Much Debt Does Zeng Hsing Industrial Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Zeng Hsing Industrial had NT$947.2m of debt, an increase on NT$410.0m, over one year. However, it does have NT$2.84b in cash offsetting this, leading to net cash of NT$1.90b.

How Healthy Is Zeng Hsing Industrial's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zeng Hsing Industrial had liabilities of NT$2.32b due within 12 months and liabilities of NT$606.3m due beyond that. Offsetting these obligations, it had cash of NT$2.84b as well as receivables valued at NT$1.23b due within 12 months. So it can boast NT$1.15b more liquid assets than total liabilities.

This short term liquidity is a sign that Zeng Hsing Industrial could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Zeng Hsing Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Zeng Hsing Industrial has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zeng Hsing Industrial'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Zeng Hsing Industrial 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. During the last three years, Zeng Hsing Industrial produced sturdy free cash flow equating to 55% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Zeng Hsing Industrial has net cash of NT$1.90b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 40% over the last year. So we don't think Zeng Hsing Industrial's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Zeng Hsing Industrial (1 doesn't sit too well with us) you should be aware of.

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. 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.
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