These 4 Measures Indicate That Tonlin Department StoreLtd (TPE:2910) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Tonlin Department Store Co.,Ltd. (TPE:2910) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tonlin Department StoreLtd

What Is Tonlin Department StoreLtd's Debt?

The chart below, which you can click on for greater detail, shows that Tonlin Department StoreLtd had NT$3.39b in debt in September 2020; about the same as the year before. However, it also had NT$476.3m in cash, and so its net debt is NT$2.91b.

How Healthy Is Tonlin Department StoreLtd's Balance Sheet?

We can see from the most recent balance sheet that Tonlin Department StoreLtd had liabilities of NT$1.50b falling due within a year, and liabilities of NT$2.41b due beyond that. Offsetting this, it had NT$476.3m in cash and NT$13.6m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$3.42b.

Tonlin Department StoreLtd has a market capitalization of NT$6.23b, 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.

With a net debt to EBITDA ratio of 12.2, it's fair to say Tonlin Department StoreLtd does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 5.3 times, suggesting it can responsibly service its obligations. If Tonlin Department StoreLtd can keep growing EBIT at last year's rate of 11% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tonlin Department StoreLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Tonlin Department StoreLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Tonlin Department StoreLtd's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Tonlin Department StoreLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. To that end, you should learn about the 2 warning signs we've spotted with Tonlin Department StoreLtd (including 1 which can't be ignored) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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