Stock Analysis

Chia Tai Enterprises International (HKG:3839) Seems To Use Debt Quite Sensibly

SEHK:3839
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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Chia Tai Enterprises International Limited (HKG:3839) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Chia Tai Enterprises International

What Is Chia Tai Enterprises International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Chia Tai Enterprises International had US$35.8m of debt, an increase on US$11.0m, over one year. However, it does have US$26.3m in cash offsetting this, leading to net debt of about US$9.45m.

debt-equity-history-analysis
SEHK:3839 Debt to Equity History September 8th 2021

A Look At Chia Tai Enterprises International's Liabilities

Zooming in on the latest balance sheet data, we can see that Chia Tai Enterprises International had liabilities of US$44.4m due within 12 months and liabilities of US$39.5m due beyond that. On the other hand, it had cash of US$26.3m and US$26.7m worth of receivables due within a year. So its liabilities total US$30.9m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$43.9m, so it does suggest shareholders should keep an eye on Chia Tai Enterprises International's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Chia Tai Enterprises International has net debt of just 1.4 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. In addition to that, we're happy to report that Chia Tai Enterprises International has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Chia Tai Enterprises International'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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Chia Tai Enterprises International burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Chia Tai Enterprises International's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Chia Tai Enterprises International's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. Case in point: We've spotted 2 warning signs for Chia Tai Enterprises International you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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