Is Cleanaway (TPE:8422) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Cleanaway Company Limited (TPE:8422) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Cleanaway

What Is Cleanaway's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Cleanaway had NT$93.0m of debt in December 2020, down from NT$360.0m, one year before. However, its balance sheet shows it holds NT$1.35b in cash, so it actually has NT$1.26b net cash.

How Healthy Is Cleanaway's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cleanaway had liabilities of NT$664.0m due within 12 months and liabilities of NT$720.5m due beyond that. On the other hand, it had cash of NT$1.35b and NT$653.7m worth of receivables due within a year. So it can boast NT$623.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Cleanaway could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Cleanaway boasts net cash, so it's fair to say it does not have a heavy debt load!

While Cleanaway doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cleanaway's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Cleanaway 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, Cleanaway recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Cleanaway has NT$1.26b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$1.8b, being 86% of its EBIT. So we don't think Cleanaway's use of debt is risky. 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 example, we've discovered 2 warning signs for Cleanaway (1 shouldn't be ignored!) that you should be aware of before investing here.

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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