Here's Why Highwealth Construction (TWSE:2542) Has A Meaningful Debt Burden

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Highwealth Construction Corp. (TWSE:2542) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Highwealth Construction

How Much Debt Does Highwealth Construction Carry?

You can click the graphic below for the historical numbers, but it shows that Highwealth Construction had NT$135.7b of debt in December 2023, down from NT$148.6b, one year before. However, it also had NT$14.8b in cash, and so its net debt is NT$120.9b.

A Look At Highwealth Construction's Liabilities

According to the last reported balance sheet, Highwealth Construction had liabilities of NT$151.1b due within 12 months, and liabilities of NT$18.4b due beyond 12 months. On the other hand, it had cash of NT$14.8b and NT$2.19b worth of receivables due within a year. So its liabilities total NT$152.5b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the NT$76.2b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Highwealth Construction would likely require a major re-capitalisation if it had to pay its creditors today.

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.

Strangely Highwealth Construction has a sky high EBITDA ratio of 10.1, implying high debt, but a strong interest coverage of 11.7. So either it has access to very cheap long term debt or that interest expense is going to grow! Pleasingly, Highwealth Construction is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 108% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Highwealth Construction's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Highwealth Construction saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Highwealth Construction's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We're quite clear that we consider Highwealth Construction to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Highwealth Construction (2 can't be ignored) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.