Would Hocheng (TPE:1810) Be Better Off With Less Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hocheng Corporation (TPE:1810) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Hocheng

How Much Debt Does Hocheng Carry?

You can click the graphic below for the historical numbers, but it shows that Hocheng had NT$3.30b of debt in September 2020, down from NT$3.49b, one year before. On the flip side, it has NT$1.30b in cash leading to net debt of about NT$2.00b.

How Healthy Is Hocheng's Balance Sheet?

We can see from the most recent balance sheet that Hocheng had liabilities of NT$3.85b falling due within a year, and liabilities of NT$1.26b due beyond that. On the other hand, it had cash of NT$1.30b and NT$1.42b worth of receivables due within a year. So its liabilities total NT$2.39b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of NT$3.83b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hocheng'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.

In the last year Hocheng had a loss before interest and tax, and actually shrunk its revenue by 5.9%, to NT$5.3b. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Hocheng produced an earnings before interest and tax (EBIT) loss. Indeed, it lost NT$8.3m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of NT$476m and the profit of NT$62m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Hocheng (2 can't be ignored!) that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. 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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