Taiwan Surface Mounting Technology (TPE:6278) Seems To Use Debt Quite Sensibly

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 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 note that Taiwan Surface Mounting Technology Corp. (TPE:6278) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Taiwan Surface Mounting Technology

What Is Taiwan Surface Mounting Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Taiwan Surface Mounting Technology had NT$5.32b of debt, an increase on NT$3.78b, over one year. However, it does have NT$7.82b in cash offsetting this, leading to net cash of NT$2.50b.

How Healthy Is Taiwan Surface Mounting Technology's Balance Sheet?

We can see from the most recent balance sheet that Taiwan Surface Mounting Technology had liabilities of NT$17.7b falling due within a year, and liabilities of NT$3.63b due beyond that. Offsetting these obligations, it had cash of NT$7.82b as well as receivables valued at NT$12.8b due within 12 months. So it has liabilities totalling NT$755.2m more than its cash and near-term receivables, combined.

Given Taiwan Surface Mounting Technology has a market capitalization of NT$35.7b, it's hard to believe these liabilities pose much threat. 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, Taiwan Surface Mounting Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Taiwan Surface Mounting Technology saw its EBIT decline by 6.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Taiwan Surface Mounting Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Taiwan Surface Mounting Technology 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. Looking at the most recent three years, Taiwan Surface Mounting Technology recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Taiwan Surface Mounting Technology's liabilities, but we can be reassured by the fact it has has net cash of NT$2.50b. So we are not troubled with Taiwan Surface Mounting Technology's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Taiwan Surface Mounting Technology is showing 2 warning signs in our investment analysis , you should know about...

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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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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