We Think Ruentex DevelopmentLtd (TPE:9945) Is Taking Some Risk With Its Debt

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.' 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. Importantly, Ruentex Development Co.,Ltd. (TPE:9945) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Ruentex DevelopmentLtd

What Is Ruentex DevelopmentLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Ruentex DevelopmentLtd had NT$47.7b of debt, an increase on NT$43.2b, over one year. However, it also had NT$6.47b in cash, and so its net debt is NT$41.2b.

How Healthy Is Ruentex DevelopmentLtd's Balance Sheet?

The latest balance sheet data shows that Ruentex DevelopmentLtd had liabilities of NT$23.4b due within a year, and liabilities of NT$46.0b falling due after that. On the other hand, it had cash of NT$6.47b and NT$3.13b worth of receivables due within a year. So it has liabilities totalling NT$59.8b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of NT$60.4b, so it does suggest shareholders should keep an eye on Ruentex DevelopmentLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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).

Ruentex DevelopmentLtd has a rather high debt to EBITDA ratio of 16.6 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. More concerning, Ruentex DevelopmentLtd saw its EBIT drop by 7.3% in the last twelve months. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ruentex DevelopmentLtd 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 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. Over the last three years, Ruentex DevelopmentLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

We'd go so far as to say Ruentex DevelopmentLtd's net debt to EBITDA was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Ruentex DevelopmentLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 Ruentex DevelopmentLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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. 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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