Stock Analysis

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

SEHK:3839
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Chia Tai Enterprises International Limited (HKG:3839) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chia Tai Enterprises International

How Much Debt Does Chia Tai Enterprises International Carry?

The chart below, which you can click on for greater detail, shows that Chia Tai Enterprises International had US$46.2m in debt in September 2022; about the same as the year before. However, it does have US$25.9m in cash offsetting this, leading to net debt of about US$20.3m.

debt-equity-history-analysis
SEHK:3839 Debt to Equity History January 30th 2023

How Strong Is Chia Tai Enterprises International's Balance Sheet?

The latest balance sheet data shows that Chia Tai Enterprises International had liabilities of US$64.9m due within a year, and liabilities of US$19.5m falling due after that. On the other hand, it had cash of US$25.9m and US$43.1m worth of receivables due within a year. So its liabilities total US$15.5m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Chia Tai Enterprises International is worth US$40.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

Looking at its net debt to EBITDA of 1.4 and interest cover of 5.7 times, it seems to us that Chia Tai Enterprises International is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Chia Tai Enterprises International grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Chia Tai Enterprises International will need earnings to service that debt. 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 investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is 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 EBIT growth rate. Looking at all this data makes us feel a little cautious about Chia Tai Enterprises International's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Chia Tai Enterprises International (2 shouldn't be ignored!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Valuation is complex, but we're helping make it simple.

Find out whether Chia Tai Enterprises International is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.