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

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.' 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. We can see that Tai Shing Electronics Components Corporation (GTSM:3426) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tai Shing Electronics Components

What Is Tai Shing Electronics Components's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Tai Shing Electronics Components had NT$80.0m of debt, an increase on NT$70.0m, over one year. However, its balance sheet shows it holds NT$648.4m in cash, so it actually has NT$568.4m net cash.

How Strong Is Tai Shing Electronics Components' Balance Sheet?

We can see from the most recent balance sheet that Tai Shing Electronics Components had liabilities of NT$218.7m falling due within a year, and liabilities of NT$122.8m due beyond that. On the other hand, it had cash of NT$648.4m and NT$164.4m worth of receivables due within a year. So it actually has NT$471.4m more liquid assets than total liabilities.

This excess liquidity is a great indication that Tai Shing Electronics Components' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. 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.

But the bad news is that Tai Shing Electronics Components has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Tai Shing Electronics Components will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. During the last three years, Tai Shing Electronics Components generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tai Shing Electronics Components has net cash of NT$568.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$36m, being 91% of its EBIT. So is Tai Shing Electronics Components's debt a risk? It doesn't seem so to us. 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. We've identified 4 warning signs with Tai Shing Electronics Components (at least 2 which make us uncomfortable) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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