Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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 can see that TTFB Company Limited (GTSM:2729) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for TTFB
What Is TTFB’s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 TTFB had debt of NT$851.9m, up from NT$100.0m in one year. But it also has NT$1.56b in cash to offset that, meaning it has NT$709.6m net cash.
How Strong Is TTFB’s Balance Sheet?
According to the last reported balance sheet, TTFB had liabilities of NT$1.02b due within 12 months, and liabilities of NT$2.41b due beyond 12 months. On the other hand, it had cash of NT$1.56b and NT$227.9m worth of receivables due within a year. So it has liabilities totalling NT$1.63b more than its cash and near-term receivables, combined.
TTFB has a market capitalization of NT$5.34b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, TTFB boasts net cash, so it’s fair to say it does not have a heavy debt load!
On the other hand, TTFB’s EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is TTFB’s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it’s definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. TTFB 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 last three years, TTFB actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While TTFB does have more liabilities than liquid assets, it also has net cash of NT$709.6m. The cherry on top was that in converted 128% of that EBIT to free cash flow, bringing in NT$883m. So we are not troubled with TTFB’s debt use. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with TTFB , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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