Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We can see that Limited Temporal Interconnect Technology (HKG:1729) uses debt in his business. But the more important question is: what risk does this debt create?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for Time Interconnect Technology
What is Time Interconnect Technology’s net debt?
You can click on the graph below for historical figures, but it shows that in September 2021, Time Interconnect Technology had HK$1.13 billion in debt, an increase from HK$1.04 billion , over one year. However, since it has a cash reserve of HK$220.9 million, its net debt is lower at around HK$906.7 million.
How strong is Time Interconnect Technology’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Time Interconnect Technology had liabilities of HK$1.60 billion due within 12 months and liabilities of HK$510.2 million due beyond. As compensation for these obligations, it had cash of HK$220.9 million and receivables valued at HK$1.04 billion due within 12 months. Thus, its liabilities total HK$853.4 million more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad since Time Interconnect Technology has a market capitalization of HK$1.79 billion, so it could likely bolster its balance sheet by raising capital if needed. But it is clear that it must be carefully examined whether he can manage his debt without dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
With a net debt to EBITDA ratio of 2.6x, interconnect technology has a pretty notable amount of debt. On the positive side, its EBIT was 7.5 times its interest expense, and its net debt to EBITDA ratio was quite high, at 2.6. It is important to note that Time Interconnect Technology’s EBIT has remained essentially stable over the last twelve months. We would prefer to see some earnings growth as this always helps reduce debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the profits of Time Interconnect Technology that will influence the balance sheet in the future. So, when considering debt, it is definitely worth looking at the earnings trend. Click here for an interactive preview.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Time Interconnect Technology has generated free cash flow of 95% of its EBIT, more than expected. This positions him well to pay off debt if desired.
Our point of view
On the balance sheet, the most notable positive for Time Interconnect Technology is the fact that it appears to be able to convert EBIT to free cash flow with confidence. However, our other observations were not so encouraging. For example, it looks like it has to struggle a bit to manage its debt, based on its EBITDA. Given this range of data points, we believe that Time Interconnect Technology is in a good position to manage its level of leverage. But be warned: we believe debt levels are high enough to warrant continued monitoring. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 2 warning signs for Time Interconnect Technology (1 of which should not be ignored!) that you should know.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.