Stock Analysis

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

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Chia Tai Enterprises International Limited (HKG:3839) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chia Tai Enterprises International

How Much Debt Does Chia Tai Enterprises International Carry?

The image below, which you can click on for greater detail, shows that at March 2023 Chia Tai Enterprises International had debt of US$56.4m, up from US$45.8m in one year. However, it does have US$29.5m in cash offsetting this, leading to net debt of about US$26.9m.

debt-equity-history-analysis
SEHK:3839 Debt to Equity History June 7th 2023

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

The latest balance sheet data shows that Chia Tai Enterprises International had liabilities of US$74.3m due within a year, and liabilities of US$20.2m falling due after that. Offsetting these obligations, it had cash of US$29.5m as well as receivables valued at US$46.9m due within 12 months. So its liabilities total US$18.1m more than the combination of its cash and short-term receivables.

Chia Tai Enterprises International has a market capitalization of US$61.4m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Chia Tai Enterprises International's net debt of 2.2 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.3 times its interest expenses harmonizes with that theme. One way Chia Tai Enterprises International could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 20%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chia Tai Enterprises International's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its EBIT growth rate was re-invigorating. We think that Chia Tai Enterprises International's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Chia Tai Enterprises International (2 are a bit unpleasant) 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.

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.