Health Check: How Prudently Does Tang Eng Iron Works (GTSM:2035) Use 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 note that Tang Eng Iron Works Co., Ltd. (GTSM:2035) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Tang Eng Iron Works

What Is Tang Eng Iron Works's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Tang Eng Iron Works had NT$8.15b of debt, an increase on NT$7.47b, over one year. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Tang Eng Iron Works' Balance Sheet?

We can see from the most recent balance sheet that Tang Eng Iron Works had liabilities of NT$2.27b falling due within a year, and liabilities of NT$10.8b due beyond that. Offsetting this, it had NT$34.2m in cash and NT$49.6m in receivables that were due within 12 months. So its liabilities total NT$13.0b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$12.6b, we think shareholders really should watch Tang Eng Iron Works's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Tang Eng Iron Works'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.

In the last year Tang Eng Iron Works had a loss before interest and tax, and actually shrunk its revenue by 13%, to NT$11b. That's not what we would hope to see.

Caveat Emptor

Not only did Tang Eng Iron Works's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$1.2b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of NT$666m over the last twelve months. That means it's on the risky side of things. 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. For example - Tang Eng Iron Works has 2 warning signs we think you should be aware of.

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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