We Think Chainqui Construction DevelopmentLtd (TPE:2509) Is Taking Some Risk With Its Debt

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 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. We note that Chainqui Construction Development Co.,Ltd (TPE:2509) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chainqui Construction DevelopmentLtd

What Is Chainqui Construction DevelopmentLtd's Debt?

As you can see below, Chainqui Construction DevelopmentLtd had NT$2.77b of debt at September 2020, down from NT$2.93b a year prior. However, it does have NT$2.28b in cash offsetting this, leading to net debt of about NT$493.9m.

A Look At Chainqui Construction DevelopmentLtd's Liabilities

The latest balance sheet data shows that Chainqui Construction DevelopmentLtd had liabilities of NT$2.14b due within a year, and liabilities of NT$1.11b falling due after that. Offsetting these obligations, it had cash of NT$2.28b as well as receivables valued at NT$54.8m due within 12 months. So its liabilities total NT$913.7m more than the combination of its cash and short-term receivables.

Chainqui Construction DevelopmentLtd has a market capitalization of NT$4.19b, so it could very likely raise cash to ameliorate 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). 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).

While Chainqui Construction DevelopmentLtd has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 2.3. This does suggest the company is paying fairly high interest rates. In any case, it's safe to say the company has meaningful debt. Shareholders should be aware that Chainqui Construction DevelopmentLtd's EBIT was down 86% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chainqui Construction DevelopmentLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Chainqui Construction DevelopmentLtd produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Chainqui Construction DevelopmentLtd's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its conversion of EBIT to free cash flow is relatively strong. Taking the abovementioned factors together we do think Chainqui Construction DevelopmentLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. Case in point: We've spotted 3 warning signs for Chainqui Construction DevelopmentLtd you should be aware of, and 1 of them is significant.

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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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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