Is ITEQ (TWSE:6213) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, ITEQ Corporation (TWSE:6213) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for ITEQ

How Much Debt Does ITEQ Carry?

The image below, which you can click on for greater detail, shows that at March 2024 ITEQ had debt of NT$5.90b, up from NT$5.05b in one year. However, it also had NT$5.48b in cash, and so its net debt is NT$418.3m.

How Healthy Is ITEQ's Balance Sheet?

According to the last reported balance sheet, ITEQ had liabilities of NT$10.5b due within 12 months, and liabilities of NT$3.82b due beyond 12 months. Offsetting this, it had NT$5.48b in cash and NT$12.8b in receivables that were due within 12 months. So it can boast NT$3.97b more liquid assets than total liabilities.

This short term liquidity is a sign that ITEQ could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, ITEQ has a very light debt load indeed.

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.

ITEQ's net debt is only 0.19 times its EBITDA. And its EBIT covers its interest expense a whopping 11.8 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, ITEQ's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine ITEQ's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, ITEQ recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

ITEQ's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Considering this range of data points, we think ITEQ is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with ITEQ , and understanding them should be part of your investment process.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com