Does Collins (TPE: 2906) have a healthy balance sheet?

Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Collins Co., Ltd. (FTE: 2906) uses debt in his business. But the most important question is: what risk does this debt create?

When Is Debt a Problem?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. The first step in examining a company’s debt levels is to consider its cash flow and debt together.

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How much debt does Collins have?

As you can see below, at the end of September 2020 Collins was in debt of NT $ 1.62 billion, up from NT $ 1.41 billion a year ago. Click on the image for more details. However, he has NT $ 1.06 billion in cash offsetting this, leading to net debt of around NT $ 560.7 million.

TSEC: 2906 History of debt versus equity March 18, 2021

A look at Collins’ responsibilities

Zooming in on the latest balance sheet data, we can see that Collins had NT $ 2.65 billion in liabilities due within 12 months and NT $ 1.25 billion in liabilities beyond. In compensation for these obligations, it had cash of NT $ 1.06 billion as well as receivables valued at NT $ 1.64 billion due within 12 months. Thus, its liabilities total NT $ 1.20 billion more than the combination of its cash and short-term receivables.

Collins has a market cap of NT $ 3.53 billion, so he could most likely raise funds to improve his balance sheet, should the need arise. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Collins’ net debt is only 1.3 times its EBITDA. And its EBIT easily covers its interest costs, being 58.4 times higher. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. The good news is that Collins increased its EBIT by 5.7% year over year, which should allay concerns about debt repayment. The balance sheet is clearly the area you need to focus on when analyzing debt. But it’s Collins’ earnings that will influence how the balance sheet looks going forward. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Collins has recorded free cash flow of 49% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.

Our point of view

Based on our analysis, Collins’ interest coverage should indicate that she won’t have too many problems with her debt. But the other factors we noted above weren’t so encouraging. For example, it seems like he’s having a bit of trouble managing his total liabilities. Given this range of data points, we believe Collins is well positioned to manage his debt levels. But beware: we believe debt levels are high enough to warrant continued monitoring. The balance sheet is clearly the area you need to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. Be aware that Collins watch 2 warning signs in our investment analysis , and 1 of them cannot be ignored …

Of course, if you are the kind of investor who prefers to buy stocks without going into debt, then feel free to find out. our exclusive list of cash net growth stocks, today.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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