Taiwan High Speed Rail (TPE:2633) Has A Somewhat Strained Balance Sheet

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.' 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. We note that Taiwan High Speed Rail Corporation (TPE:2633) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Taiwan High Speed Rail

How Much Debt Does Taiwan High Speed Rail Carry?

The chart below, which you can click on for greater detail, shows that Taiwan High Speed Rail had NT$276.1b in debt in December 2020; about the same as the year before. However, it does have NT$33.6b in cash offsetting this, leading to net debt of about NT$242.5b.

A Look At Taiwan High Speed Rail's Liabilities

We can see from the most recent balance sheet that Taiwan High Speed Rail had liabilities of NT$7.07b falling due within a year, and liabilities of NT$350.4b due beyond that. Offsetting this, it had NT$33.6b in cash and NT$1.46b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$322.4b.

This deficit casts a shadow over the NT$177.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Taiwan High Speed Rail would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 2.0 times and a disturbingly high net debt to EBITDA ratio of 9.4 hit our confidence in Taiwan High Speed Rail like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Worse, Taiwan High Speed Rail's EBIT was down 42% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that 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 Taiwan High Speed Rail'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, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Taiwan High Speed Rail generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

To be frank both Taiwan High Speed Rail's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. It's also worth noting that Taiwan High Speed Rail is in the Infrastructure industry, which is often considered to be quite defensive. We're quite clear that we consider Taiwan High Speed Rail to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 High Speed Rail is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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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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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