Warren Buffett famously said, '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 Top Union Electronics Corp. (GTSM:6266) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Top Union Electronics Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Top Union Electronics had NT$327.0m of debt, an increase on NT$279.0m, over one year. However, its balance sheet shows it holds NT$434.4m in cash, so it actually has NT$107.4m net cash.
How Healthy Is Top Union Electronics' Balance Sheet?
According to the last reported balance sheet, Top Union Electronics had liabilities of NT$694.8m due within 12 months, and liabilities of NT$53.7m due beyond 12 months. Offsetting these obligations, it had cash of NT$434.4m as well as receivables valued at NT$367.8m due within 12 months. So it actually has NT$53.6m more liquid assets than total liabilities.
This short term liquidity is a sign that Top Union Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Top Union Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Top Union Electronics saw its EBIT decline by 3.0% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Top Union Electronics's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Top Union Electronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Top Union Electronics created free cash flow amounting to 16% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to investigate a company's debt, in this case Top Union Electronics has NT$107.4m in net cash and a decent-looking balance sheet. So we don't have any problem with Top Union Electronics's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Top Union Electronics you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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