Is Taiwan Thick-Film Ind (GTSM:6246) 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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Taiwan Thick-Film Ind. Corp (GTSM:6246) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Taiwan Thick-Film Ind

What Is Taiwan Thick-Film Ind's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Taiwan Thick-Film Ind had NT$301.7m of debt, an increase on NT$255.0m, over one year. On the flip side, it has NT$136.5m in cash leading to net debt of about NT$165.2m.

How Healthy Is Taiwan Thick-Film Ind's Balance Sheet?

According to the last reported balance sheet, Taiwan Thick-Film Ind had liabilities of NT$622.7m due within 12 months, and liabilities of NT$131.1m due beyond 12 months. On the other hand, it had cash of NT$136.5m and NT$554.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$63.2m.

Since publicly traded Taiwan Thick-Film Ind shares are worth a total of NT$461.4m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.74 times and a disturbingly high net debt to EBITDA ratio of 5.9 hit our confidence in Taiwan Thick-Film Ind like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for Taiwan Thick-Film Ind is that it turned last year's EBIT loss into a gain of NT$7.4m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Taiwan Thick-Film Ind'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Taiwan Thick-Film Ind saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Taiwan Thick-Film Ind's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to handle its total liabilities isn't such a worry. Looking at the bigger picture, it seems clear to us that Taiwan Thick-Film Ind's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Taiwan Thick-Film Ind (including 2 which don't sit too well with us) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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