TAI-TECH Advanced Electronics (GTSM:3357) Could Easily Take On More Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, TAI-TECH Advanced Electronics Co., Ltd. (GTSM:3357) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for TAI-TECH Advanced Electronics

How Much Debt Does TAI-TECH Advanced Electronics Carry?

As you can see below, at the end of December 2020, TAI-TECH Advanced Electronics had NT$1.16b of debt, up from NT$1.09b a year ago. Click the image for more detail. However, it also had NT$934.7m in cash, and so its net debt is NT$229.9m.

How Strong Is TAI-TECH Advanced Electronics' Balance Sheet?

The latest balance sheet data shows that TAI-TECH Advanced Electronics had liabilities of NT$2.17b due within a year, and liabilities of NT$442.2m falling due after that. Offsetting this, it had NT$934.7m in cash and NT$1.80b in receivables that were due within 12 months. So it actually has NT$120.0m more liquid assets than total liabilities.

Having regard to TAI-TECH Advanced Electronics' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$13.1b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). 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).

TAI-TECH Advanced Electronics has net debt of just 0.19 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. In addition to that, we're happy to report that TAI-TECH Advanced Electronics has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is TAI-TECH Advanced Electronics'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, TAI-TECH Advanced Electronics's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that TAI-TECH Advanced Electronics's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think TAI-TECH Advanced Electronics's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for TAI-TECH Advanced Electronics you should know about.

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.

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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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