Stock Analysis

Does Chia Tai Enterprises International (HKG:3839) Have A Healthy Balance Sheet?

SEHK:3839
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Chia Tai Enterprises International Limited (HKG:3839) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chia Tai Enterprises International

How Much Debt Does Chia Tai Enterprises International Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Chia Tai Enterprises International had US$20.5m of debt, an increase on US$16.0m, over one year. However, it does have US$32.3m in cash offsetting this, leading to net cash of US$11.8m.

debt-equity-history-analysis
SEHK:3839 Debt to Equity History April 27th 2021

A Look At Chia Tai Enterprises International's Liabilities

According to the last reported balance sheet, Chia Tai Enterprises International had liabilities of US$41.7m due within 12 months, and liabilities of US$38.4m due beyond 12 months. Offsetting these obligations, it had cash of US$32.3m as well as receivables valued at US$19.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$28.1m.

This deficit isn't so bad because Chia Tai Enterprises International is worth US$50.9m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Chia Tai Enterprises International also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Chia Tai Enterprises International's saving grace is its low debt levels, because its EBIT has tanked 65% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Chia Tai Enterprises International has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Chia Tai Enterprises International saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Chia Tai Enterprises International's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$11.8m. Despite the cash, we do find Chia Tai Enterprises International's EBIT growth rate concerning, so we're not particularly comfortable with the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Chia Tai Enterprises International , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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