Thinking Electronic Industrial (TPE:2428) Could Easily Take On More Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Thinking Electronic Industrial Co., Ltd. (TPE:2428) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Thinking Electronic Industrial

What Is Thinking Electronic Industrial's Debt?

As you can see below, at the end of September 2020, Thinking Electronic Industrial had NT$824.4m of debt, up from NT$105.0m a year ago. Click the image for more detail. But it also has NT$3.99b in cash to offset that, meaning it has NT$3.16b net cash.

A Look At Thinking Electronic Industrial's Liabilities

Zooming in on the latest balance sheet data, we can see that Thinking Electronic Industrial had liabilities of NT$2.11b due within 12 months and liabilities of NT$1.10b due beyond that. On the other hand, it had cash of NT$3.99b and NT$2.22b worth of receivables due within a year. So it can boast NT$3.00b more liquid assets than total liabilities.

This surplus suggests that Thinking Electronic Industrial has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Thinking Electronic Industrial has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Thinking Electronic Industrial has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Thinking Electronic Industrial'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Thinking Electronic Industrial 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. Over the most recent three years, Thinking Electronic Industrial recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Thinking Electronic Industrial has net cash of NT$3.16b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 28% over the last year. So we don't think Thinking Electronic Industrial's use of debt is risky. 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. For instance, we've identified 2 warning signs for Thinking Electronic Industrial that you should be aware of.

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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