Does Tatung Fine Chemicals (GTSM:4738) 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.' 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. Importantly, Tatung Fine Chemicals Co. (GTSM:4738) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tatung Fine Chemicals

What Is Tatung Fine Chemicals's Debt?

You can click the graphic below for the historical numbers, but it shows that Tatung Fine Chemicals had NT$115.5m of debt in December 2020, down from NT$127.6m, one year before. However, its balance sheet shows it holds NT$124.7m in cash, so it actually has NT$9.20m net cash.

How Healthy Is Tatung Fine Chemicals' Balance Sheet?

We can see from the most recent balance sheet that Tatung Fine Chemicals had liabilities of NT$149.6m falling due within a year, and liabilities of NT$94.9m due beyond that. On the other hand, it had cash of NT$124.7m and NT$83.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$36.0m.

Since publicly traded Tatung Fine Chemicals shares are worth a total of NT$861.3m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Tatung Fine Chemicals also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tatung Fine Chemicals 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.

In the last year Tatung Fine Chemicals had a loss before interest and tax, and actually shrunk its revenue by 7.3%, to NT$240m. We would much prefer see growth.

So How Risky Is Tatung Fine Chemicals?

Although Tatung Fine Chemicals had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of NT$32m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. We've identified 2 warning signs with Tatung Fine Chemicals , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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