TOYO (NASDAQ:TOYO) takes some risk by using debt

Warren Buffett famously said, “Volatility is far from synonymous with risk.” So it seems that smart people know that debt – which usually accompanies bankruptcies – is a very important factor when assessing a company’s risk. What is important is TOYO Co., Ltd. (NASDAQ:TOYO) carries debt. But should shareholders be concerned about the use of debt?

When is debt dangerous?

Debt and other liabilities become risky for a company when it cannot easily meet those obligations, either through free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While this isn’t all that common, we often see indebted companies permanently diluting their shareholders because lenders force them to raise capital at a distressed price. However, as a replacement for dilution, debt can be an extremely good tool for companies that need capital to invest in growth at high returns. When we examine debt levels, we first consider both cash and debt levels together.

Check out our latest analysis for TOYO

How much debt does TOYO have?

The image below, which you can click on for more details, shows that TOYO had $121.6 million in debt as of June 2024, an increase from none in a year. However, since the company has a cash reserve of $41.7 million, its net debt is less, at about $79.9 million.

How healthy is TOYO’s balance sheet?

The latest balance sheet data shows that TOYO had liabilities of US$145.4m within a year, and liabilities of US$22.6m falling due after that. Offsetting this, it had US$41.7m in cash and US$121.1k in receivables that were due within 12 months. So it has liabilities totaling US$126.2m more than its cash and short-term receivables combined.

This is huge leverage relative to its market cap of $207.6 million. If the lenders demand a restructuring of the balance sheet, shareholders would likely face severe dilution.

To measure 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). The advantage of this approach is that we take into account 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 debt to EBITDA ratio of 1.6, TOYO handles debt smartly but responsibly. And the fact that EBIT was 7.4 times interest expense over the last twelve months fits this theme. Better yet, TOYO grew its EBIT by 573% last year, which is an impressive improvement. This boost will make it even easier to pay off debt in the future. When analyzing debt levels, the balance sheet is the obvious place to start. But it is TOYO’s earnings that will influence how its balance sheet develops in the future. So when thinking about debt, it’s definitely worth taking a look at earnings performance. Click here for an interactive snapshot.

And finally, while the tax officer is happy about accounting profits, lenders only accept cold hard cash. So the logical step is to examine the proportion of that EBIT that corresponds to actual free cash flow. TOYO has burned a lot of money in the last two years. While investors undoubtedly expect this situation to reverse in due course, it clearly means that using debt is riskier.

Our view

TOYO’s conversion of EBIT to free cash flow and the size of its total liabilities are definitely weighing on it in our opinion. But the EBIT growth rate tells a completely different story and suggests a certain level of resilience. After considering the above data points, we believe that TOYO’s debt makes the company somewhat risky. Not all risk is bad, as it can boost stock price returns if it pays off, but this debt risk is worth keeping an eye on. There is no doubt that the balance sheet is where we learn the most about debt. However, not all investment risks lie on the balance sheet – quite the opposite. For example, we identified 5 warning signs for TOYO (4 are worrisome) You should be aware of this.

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 immediately.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.