These 4 Measures Indicate That Ta-Yuan Cogeneration (GTSM:8931) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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, Ta-Yuan Cogeneration Company Ltd. (GTSM:8931) does carry debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Ta-Yuan Cogeneration

What Is Ta-Yuan Cogeneration's Debt?

As you can see below, at the end of September 2020, Ta-Yuan Cogeneration had NT$2.18b of debt, up from NT$1.41b a year ago. Click the image for more detail. However, it does have NT$519.2m in cash offsetting this, leading to net debt of about NT$1.66b.

How Healthy Is Ta-Yuan Cogeneration's Balance Sheet?

The latest balance sheet data shows that Ta-Yuan Cogeneration had liabilities of NT$2.00b due within a year, and liabilities of NT$384.1m falling due after that. Offsetting these obligations, it had cash of NT$519.2m as well as receivables valued at NT$217.6m due within 12 months. So it has liabilities totalling NT$1.65b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Ta-Yuan Cogeneration has a market capitalization of NT$3.64b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Ta-Yuan Cogeneration has a debt to EBITDA ratio of 4.1, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 701 is very high, suggesting that the interest expense on the debt is currently quite low. It is well worth noting that Ta-Yuan Cogeneration's EBIT shot up like bamboo after rain, gaining 51% in the last twelve months. That'll make it easier to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Ta-Yuan Cogeneration'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ta-Yuan Cogeneration saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We feel some trepidation about Ta-Yuan Cogeneration's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Ta-Yuan Cogeneration is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Ta-Yuan Cogeneration you should be aware of, and 1 of them doesn't sit too well with us.

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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