Tian Zheng International Precision Machinery (GTSM:6654) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Tian Zheng International Precision Machinery Co., Ltd. (GTSM:6654) makes use of 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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tian Zheng International Precision Machinery

How Much Debt Does Tian Zheng International Precision Machinery Carry?

As you can see below, Tian Zheng International Precision Machinery had NT$195.0m of debt at September 2020, down from NT$320.0m a year prior. However, it does have NT$456.3m in cash offsetting this, leading to net cash of NT$261.3m.

How Healthy Is Tian Zheng International Precision Machinery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tian Zheng International Precision Machinery had liabilities of NT$444.7m due within 12 months and liabilities of NT$72.4m due beyond that. Offsetting this, it had NT$456.3m in cash and NT$373.9m in receivables that were due within 12 months. So it actually has NT$313.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Tian Zheng International Precision Machinery could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tian Zheng International Precision Machinery has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Tian Zheng International Precision Machinery's saving grace is its low debt levels, because its EBIT has tanked 52% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Tian Zheng International Precision Machinery's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tian Zheng International Precision Machinery may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Tian Zheng International Precision Machinery recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tian Zheng International Precision Machinery has net cash of NT$261.3m, as well as more liquid assets than liabilities. So we don't have any problem with Tian Zheng International Precision Machinery's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Tian Zheng International Precision Machinery .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

If you’re looking to trade Tian Zheng International Precision Machinery, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.