Is Darwin Precisions (TPE:6120) Using Debt In A Risky Way?

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.' 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. Importantly, Darwin Precisions Corporation (TPE:6120) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Darwin Precisions

How Much Debt Does Darwin Precisions Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Darwin Precisions had NT$3.78b of debt, an increase on NT$3.14b, over one year. However, it does have NT$5.55b in cash offsetting this, leading to net cash of NT$1.78b.

A Look At Darwin Precisions' Liabilities

We can see from the most recent balance sheet that Darwin Precisions had liabilities of NT$5.15b falling due within a year, and liabilities of NT$4.67b due beyond that. Offsetting these obligations, it had cash of NT$5.55b as well as receivables valued at NT$3.94b due within 12 months. So it has liabilities totalling NT$319.6m more than its cash and near-term receivables, combined.

Of course, Darwin Precisions has a market capitalization of NT$11.6b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Darwin Precisions boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Darwin Precisions 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.

Over 12 months, Darwin Precisions made a loss at the EBIT level, and saw its revenue drop to NT$14b, which is a fall of 9.8%. That's not what we would hope to see.

So How Risky Is Darwin Precisions?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Darwin Precisions had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through NT$1.2b of cash and made a loss of NT$1.2b. With only NT$1.78b on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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. We've identified 2 warning signs with Darwin Precisions (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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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