Eurocharm Holdings (TPE:5288) Has A Pretty Healthy Balance Sheet

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Eurocharm Holdings Co., Ltd. (TPE:5288) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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.

Check out our latest analysis for Eurocharm Holdings

What Is Eurocharm Holdings's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Eurocharm Holdings had debt of NT$1.04b, up from NT$854.1m in one year. But it also has NT$1.46b in cash to offset that, meaning it has NT$421.2m net cash.

How Strong Is Eurocharm Holdings's Balance Sheet?

We can see from the most recent balance sheet that Eurocharm Holdings had liabilities of NT$1.81b falling due within a year, and liabilities of NT$39.7m due beyond that. Offsetting this, it had NT$1.46b in cash and NT$850.9m in receivables that were due within 12 months. So it can boast NT$458.1m more liquid assets than total liabilities.

This surplus suggests that Eurocharm Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Eurocharm Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Eurocharm Holdings if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Eurocharm Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Eurocharm Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Eurocharm Holdings's free cash flow amounted to 40% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Eurocharm Holdings has NT$421.2m in net cash and a decent-looking balance sheet. So we are not troubled with Eurocharm Holdings's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Eurocharm Holdings , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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