Tong Hsing Electronic Industries (TPE:6271) Seems To Use Debt Quite Sensibly

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. Importantly, Tong Hsing Electronic Industries, Ltd. (TPE:6271) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Tong Hsing Electronic Industries

What Is Tong Hsing Electronic Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Tong Hsing Electronic Industries had NT$548.0m of debt, an increase on NT$178.4m, over one year. But it also has NT$5.08b in cash to offset that, meaning it has NT$4.53b net cash.

How Strong Is Tong Hsing Electronic Industries's Balance Sheet?

We can see from the most recent balance sheet that Tong Hsing Electronic Industries had liabilities of NT$4.20b falling due within a year, and liabilities of NT$397.2m due beyond that. On the other hand, it had cash of NT$5.08b and NT$1.83b worth of receivables due within a year. So it can boast NT$2.31b more liquid assets than total liabilities.

This short term liquidity is a sign that Tong Hsing Electronic Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Tong Hsing Electronic Industries boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Tong Hsing Electronic Industries grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Tong Hsing Electronic Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Tong Hsing Electronic Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Tong Hsing Electronic Industries created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Tong Hsing Electronic Industries has net cash of NT$4.53b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 77% over the last year. So is Tong Hsing Electronic Industries's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. 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 Tong Hsing Electronic Industries you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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