Does Tah Kong Chemical Industrial (GTSM:4706) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tah Kong Chemical Industrial Corporation (GTSM:4706) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tah Kong Chemical Industrial

What Is Tah Kong Chemical Industrial's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Tah Kong Chemical Industrial had debt of NT$68.4m, up from NT$37.3m in one year. But it also has NT$609.3m in cash to offset that, meaning it has NT$540.9m net cash.

A Look At Tah Kong Chemical Industrial's Liabilities

Zooming in on the latest balance sheet data, we can see that Tah Kong Chemical Industrial had liabilities of NT$217.9m due within 12 months and liabilities of NT$14.3m due beyond that. Offsetting these obligations, it had cash of NT$609.3m as well as receivables valued at NT$307.8m due within 12 months. So it can boast NT$684.9m more liquid assets than total liabilities.

This surplus strongly suggests that Tah Kong Chemical Industrial has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Tah Kong Chemical Industrial has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Tah Kong Chemical Industrial if management cannot prevent a repeat of the 25% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tah Kong Chemical Industrial 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tah Kong Chemical Industrial has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Tah Kong Chemical Industrial actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Tah Kong Chemical Industrial has NT$540.9m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$241m, being 144% of its EBIT. So we don't think Tah Kong Chemical Industrial's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Tah Kong Chemical Industrial (1 makes us a bit uncomfortable) 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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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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