Warren Buffett famously said, “Volatility is far from synonymous with risk.” So it seems like the smart money knows that debt – which is usually involved in bankruptcy – is a very important factor when judging how risky a business is. We note that Shiny Chemical Industrial Company Limited (TPE: 1773) has debt on the balance sheet. But should shareholders be concerned about using debt?
When is guilt dangerous?
Debt and other liabilities become risky for a company when it cannot easily meet those liabilities, either with free cash flow or by raising capital at an attractive price. When things get really bad, the lenders can take control of the business. A more common (but still costly) event, however, is that a company has to issue shares at bargain prices, permanently diluting shareholders just to keep its balance sheet up. That said, the most common situation is when a company is managing its debt quite well – and for its own benefit. When we examine debt levels, we first look at both cash and debt levels together.
What is Shiny Chemical Industrial’s net debt?
As you can see below, Shiny Chemical Industrial was in debt of NT $ 963.9 million at the end of December 2020, up from NT $ 804.0 million a year ago. Click on the image for more details. However, it also had NT $ 443.9 million in cash, so the net debt is NT $ 520.0 million.
How healthy is Shiny Chemical Industrial’s balance sheet?
The most recent balance sheet data shows that Shiny Chemical Industrial had debt of NT $ 1.70 billion within one year and debt of NT $ 769.1 million due thereafter. To offset these obligations, it had cash of NT $ 443.9 million and receivables of NT $ 1.29 billion due within 12 months. So his liabilities outweigh the sum of his cash and (short-term) receivables by NT $ 736.3 million.
Of course, Shiny Chemical Industrial has a market cap of NT $ 21.6 billion, so these liabilities are probably manageable. However, we think it’s worth keeping an eye on the strength of the balance as it can change over time.
To match a company’s debt to income, we calculate net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA) and earnings before interest and taxes (EBIT) divided by interest expense (its interest coverage) . In this way, we look at both the absolute amount of the debt and the interest rates paid on it.
Shiny Chemical Industrial has a low net debt / EBITDA ratio of only 0.31. And his EBIT covers his interest charges no less than 755 times. So you could say that he is no more threatened by his guilt than an elephant by a mouse. In addition, we are pleased to announce that Shiny Chemical Industrial has increased its EBIT by 39%, reducing the specter of future debt repayments. When analyzing debt levels, balance sheet is the obvious place to start. But it’s Shiny Chemical Industrial’s revenues that will affect how the balance sheet holds up going forward. So if you are considering debt, it is definitely worth looking at the earnings development. Click here for an interactive snapshot.
Finally, while the tax office may love accounting profits, lenders only accept cold hard cash. So the logical step is to look at the part of that EBIT that corresponds to the actual free cash flow. Over the past three years, Shiny Chemical Industrial reported free cash flow of 6.6% of its EBIT, which is really quite low. For us, cash conversion causing a bit of paranoia is the ability to pay off debt.
The good news is that Shiny Chemical Industrial’s proven ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the hard truth is that we are concerned about converting EBIT to free cash flow. Considering all this data, it seems to us that Shiny Chemical Industrial is reasonably debt-wise. That means they are taking a little more risk, hoping to boost shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks are in the balance sheet – far from it. For example, we have discovered 1 warning sign for Shiny Chemical Industrial which you should be aware of before investing here.
After all that, if you’re more interested in a fast-growing company with a rock-solid balance sheet, check it out our list of net cash growth stocks without delay.
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