Is Tai Shing Electronics Components (GTSM:3426) Using Too Much Debt?

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 Tai Shing Electronics Components Corporation (GTSM:3426) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Tai Shing Electronics Components

How Much Debt Does Tai Shing Electronics Components Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Tai Shing Electronics Components had debt of NT$80.0m, up from NT$70.0m in one year. However, it does have NT$648.4m in cash offsetting this, leading to net cash of NT$568.4m.

A Look At Tai Shing Electronics Components's Liabilities

According to the last reported balance sheet, Tai Shing Electronics Components had liabilities of NT$218.7m due within 12 months, and liabilities of NT$122.8m due beyond 12 months. On the other hand, it had cash of NT$648.4m and NT$164.4m worth of receivables due within a year. So it can boast NT$471.4m more liquid assets than total liabilities.

This surplus strongly suggests that Tai Shing Electronics Components has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Tai Shing Electronics Components has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Tai Shing Electronics Components's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tai Shing Electronics Components 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tai Shing Electronics Components has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Tai Shing Electronics Components recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to investigate a company's debt, in this case Tai Shing Electronics Components has NT$568.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in NT$36m. So we don't think Tai Shing Electronics Components's use of debt is risky. 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. For example, we've discovered 4 warning signs for Tai Shing Electronics Components (2 are potentially serious!) that you should be aware of before investing here.

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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