Roo Hsing (TPE:4414) Has A Somewhat Strained Balance Sheet

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Roo Hsing Co., Ltd (TPE:4414) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Roo Hsing

What Is Roo Hsing's Debt?

The image below, which you can click on for greater detail, shows that Roo Hsing had debt of NT$7.34b at the end of September 2020, a reduction from NT$8.53b over a year. However, it does have NT$1.05b in cash offsetting this, leading to net debt of about NT$6.29b.

A Look At Roo Hsing's Liabilities

The latest balance sheet data shows that Roo Hsing had liabilities of NT$11.3b due within a year, and liabilities of NT$1.07b falling due after that. Offsetting this, it had NT$1.05b in cash and NT$5.00b in receivables that were due within 12 months. So its liabilities total NT$6.36b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of NT$9.09b, so it does suggest shareholders should keep an eye on Roo Hsing's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Roo Hsing shareholders face the double whammy of a high net debt to EBITDA ratio (8.6), and fairly weak interest coverage, since EBIT is just 0.076 times the interest expense. This means we'd consider it to have a heavy debt load. However, the silver lining was that Roo Hsing achieved a positive EBIT of NT$24m in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is Roo Hsing'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Roo Hsing actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Roo Hsing's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that Roo Hsing is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 1 warning sign for Roo Hsing that you should be aware of before investing here.

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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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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