Does Tung Ho Steel Enterprise (TPE:2006) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Tung Ho Steel Enterprise Corporation (TPE:2006) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tung Ho Steel Enterprise

What Is Tung Ho Steel Enterprise's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Tung Ho Steel Enterprise had NT$9.09b of debt in December 2020, down from NT$17.1b, one year before. On the flip side, it has NT$2.09b in cash leading to net debt of about NT$7.00b.

A Look At Tung Ho Steel Enterprise's Liabilities

Zooming in on the latest balance sheet data, we can see that Tung Ho Steel Enterprise had liabilities of NT$13.8b due within 12 months and liabilities of NT$2.90b due beyond that. Offsetting this, it had NT$2.09b in cash and NT$6.07b in receivables that were due within 12 months. So it has liabilities totalling NT$8.55b more than its cash and near-term receivables, combined.

Given Tung Ho Steel Enterprise has a market capitalization of NT$51.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tung Ho Steel Enterprise has a low net debt to EBITDA ratio of only 1.2. And its EBIT easily covers its interest expense, being 27.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Tung Ho Steel Enterprise grew its EBIT by 109% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tung Ho Steel Enterprise's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Tung Ho Steel Enterprise produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that Tung Ho Steel Enterprise's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, Tung Ho Steel Enterprise seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 example, we've discovered 3 warning signs for Tung Ho Steel Enterprise that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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