Taiwan Chinsan Electronic Industrial (GTSM:8042) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Taiwan Chinsan Electronic Industrial Co., Ltd. (GTSM:8042) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Taiwan Chinsan Electronic Industrial

What Is Taiwan Chinsan Electronic Industrial's Debt?

The chart below, which you can click on for greater detail, shows that Taiwan Chinsan Electronic Industrial had NT$2.58b in debt in September 2020; about the same as the year before. On the flip side, it has NT$1.54b in cash leading to net debt of about NT$1.04b.

A Look At Taiwan Chinsan Electronic Industrial's Liabilities

According to the last reported balance sheet, Taiwan Chinsan Electronic Industrial had liabilities of NT$2.71b due within 12 months, and liabilities of NT$1.14b due beyond 12 months. Offsetting these obligations, it had cash of NT$1.54b as well as receivables valued at NT$1.60b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$709.7m.

Of course, Taiwan Chinsan Electronic Industrial has a market capitalization of NT$5.70b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt to EBITDA of 3.1 Taiwan Chinsan Electronic Industrial has a fairly noticeable amount of debt. On the plus side, its EBIT was 9.7 times its interest expense, and its net debt to EBITDA, was quite high, at 3.1. Notably, Taiwan Chinsan Electronic Industrial's EBIT launched higher than Elon Musk, gaining a whopping 286% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Taiwan Chinsan Electronic Industrial 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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Taiwan Chinsan Electronic Industrial recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Taiwan Chinsan Electronic Industrial's impressive EBIT growth rate implies it has the upper hand on its debt. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. When we consider the range of factors above, it looks like Taiwan Chinsan Electronic Industrial is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that Taiwan Chinsan Electronic Industrial is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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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