Is Ta Chen Stainless Pipe (TPE:2027) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Ta Chen Stainless Pipe Co., Ltd. (TPE:2027) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ta Chen Stainless Pipe

How Much Debt Does Ta Chen Stainless Pipe Carry?

As you can see below, at the end of September 2020, Ta Chen Stainless Pipe had NT$59.0b of debt, up from NT$53.9b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$9.34b, its net debt is less, at about NT$49.6b.

A Look At Ta Chen Stainless Pipe's Liabilities

Zooming in on the latest balance sheet data, we can see that Ta Chen Stainless Pipe had liabilities of NT$26.5b due within 12 months and liabilities of NT$46.5b due beyond that. On the other hand, it had cash of NT$9.34b and NT$5.62b worth of receivables due within a year. So it has liabilities totalling NT$58.0b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of NT$49.9b, we think shareholders really should watch Ta Chen Stainless Pipe's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.40 times and a disturbingly high net debt to EBITDA ratio of 25.0 hit our confidence in Ta Chen Stainless Pipe like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Ta Chen Stainless Pipe's EBIT was down 91% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Ta Chen Stainless Pipe'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Ta Chen Stainless Pipe burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Ta Chen Stainless Pipe's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. We think the chances that Ta Chen Stainless Pipe has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Ta Chen Stainless Pipe (1 shouldn't be ignored) you should be aware of.

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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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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