We Think TSC Auto ID Technology (GTSM:3611) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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. Importantly, TSC Auto ID Technology Co., Ltd. (GTSM:3611) does carry debt. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TSC Auto ID Technology

How Much Debt Does TSC Auto ID Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 TSC Auto ID Technology had NT$2.10b of debt, an increase on NT$1.77b, over one year. However, it does have NT$1.13b in cash offsetting this, leading to net debt of about NT$968.2m.

A Look At TSC Auto ID Technology's Liabilities

According to the last reported balance sheet, TSC Auto ID Technology had liabilities of NT$1.73b due within 12 months, and liabilities of NT$1.91b due beyond 12 months. On the other hand, it had cash of NT$1.13b and NT$942.5m worth of receivables due within a year. So it has liabilities totalling NT$1.56b more than its cash and near-term receivables, combined.

Since publicly traded TSC Auto ID Technology shares are worth a total of NT$8.41b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

TSC Auto ID Technology's net debt is only 0.91 times its EBITDA. And its EBIT easily covers its interest expense, being 51.8 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that TSC Auto ID Technology saw its EBIT decline by 7.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if TSC Auto ID Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, TSC Auto ID Technology recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

Happily, TSC Auto ID Technology's impressive interest cover implies it has the upper hand on its debt. But, on a more sombre note, we are a little concerned by its EBIT growth rate. When we consider the range of factors above, it looks like TSC Auto ID Technology is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for TSC Auto ID Technology 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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