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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Ta Chen Stainless Pipe Co., Ltd. (TWSE:2027) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Ta Chen Stainless Pipe

How Much Debt Does Ta Chen Stainless Pipe Carry?

The image below, which you can click on for greater detail, shows that Ta Chen Stainless Pipe had debt of NT$42.7b at the end of December 2023, a reduction from NT$52.6b over a year. However, it does have NT$11.8b in cash offsetting this, leading to net debt of about NT$30.9b.

How Strong Is Ta Chen Stainless Pipe's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ta Chen Stainless Pipe had liabilities of NT$28.0b due within 12 months and liabilities of NT$32.6b due beyond that. On the other hand, it had cash of NT$11.8b and NT$9.00b worth of receivables due within a year. So its liabilities total NT$39.8b more than the combination of its cash and short-term receivables.

Ta Chen Stainless Pipe has a market capitalization of NT$78.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Ta Chen Stainless Pipe's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 6.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Ta Chen Stainless Pipe's EBIT fell a jaw-dropping 52% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ta Chen Stainless Pipe can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Ta Chen Stainless Pipe recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Ta Chen Stainless Pipe's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its conversion of EBIT to free cash flow was re-invigorating. Taking the abovementioned factors together we do think Ta Chen Stainless Pipe's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Ta Chen Stainless Pipe you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.