Does Delpha ConstructionLtd (TWSE:2530) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. 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?

The image below, which you can click on for greater detail, shows that at September 2023 Delpha ConstructionLtd had debt of NT$10.1b, up from NT$8.28b in one year. However, because it has a cash reserve of NT$814.5m, its net debt is less, at about NT$9.24b.

A Look At Delpha ConstructionLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Delpha ConstructionLtd had liabilities of NT$11.2b due within 12 months and liabilities of NT$1.46b due beyond that. Offsetting these obligations, it had cash of NT$814.5m as well as receivables valued at NT$20.3m due within 12 months. So its liabilities total NT$11.8b more than the combination of its cash and short-term receivables.

Delpha ConstructionLtd has a market capitalization of NT$35.3b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Delpha ConstructionLtd has a sky high EBITDA ratio of 34.6, implying high debt, but a strong interest coverage of 34.3. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Delpha ConstructionLtd's EBIT launched higher than Elon Musk, gaining a whopping 506% on last year. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 two years, Delpha ConstructionLtd burned a lot of cash. 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

While Delpha ConstructionLtd's conversion of EBIT to free cash flow has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Delpha ConstructionLtd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Delpha ConstructionLtd has 1 warning sign we think 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. 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.