Would Taiwan Tea (TPE:2913) Be Better Off With Less 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.' 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 Taiwan Tea Corporation (TPE:2913) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Taiwan Tea

What Is Taiwan Tea's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Taiwan Tea had debt of NT$5.92b, up from NT$5.40b in one year. However, it also had NT$176.1m in cash, and so its net debt is NT$5.75b.

A Look At Taiwan Tea's Liabilities

According to the last reported balance sheet, Taiwan Tea had liabilities of NT$1.00b due within 12 months, and liabilities of NT$8.30b due beyond 12 months. Offsetting this, it had NT$176.1m in cash and NT$24.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$9.11b.

This is a mountain of leverage relative to its market capitalization of NT$13.7b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Taiwan Tea will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Taiwan Tea reported revenue of NT$312m, which is a gain of 4.3%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Taiwan Tea produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at NT$148m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through NT$650m of cash over the last year. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Taiwan Tea you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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