Delpha ConstructionLtd (TWSE:2530) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Delpha Construction Co.,Ltd. (TWSE:2530) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Delpha ConstructionLtd

What Is Delpha ConstructionLtd's Net Debt?

As you can see below, at the end of March 2024, Delpha ConstructionLtd had NT$10.6b of debt, up from NT$8.92b a year ago. Click the image for more detail. However, it also had NT$1.29b in cash, and so its net debt is NT$9.29b.

How Healthy Is Delpha ConstructionLtd's Balance Sheet?

The latest balance sheet data shows that Delpha ConstructionLtd had liabilities of NT$12.6b due within a year, and liabilities of NT$1.60b falling due after that. Offsetting these obligations, it had cash of NT$1.29b as well as receivables valued at NT$256.7m due within 12 months. So it has liabilities totalling NT$12.7b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Delpha ConstructionLtd has a market capitalization of NT$45.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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).

As it happens Delpha ConstructionLtd has a fairly concerning net debt to EBITDA ratio of 9.9 but very strong interest coverage of 104. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Delpha ConstructionLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 163% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Delpha ConstructionLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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 last two years, Delpha ConstructionLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Delpha ConstructionLtd's conversion of EBIT to free cash flow was a real negative on this analysis, as was its net debt to EBITDA. But its interest cover was significantly redeeming. Looking at all this data makes us feel a little cautious about Delpha ConstructionLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Be aware that Delpha ConstructionLtd is showing 1 warning sign in our investment analysis , 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.

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