Is Hung Chou Fiber Ind (TPE:1413) Using Debt In A Risky Way?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Hung Chou Fiber Ind. Co., Ltd (TPE:1413) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Hung Chou Fiber Ind

What Is Hung Chou Fiber Ind's Net Debt?

As you can see below, at the end of September 2020, Hung Chou Fiber Ind had NT$1.18b of debt, up from NT$587.5m a year ago. Click the image for more detail. However, it does have NT$72.5m in cash offsetting this, leading to net debt of about NT$1.11b.

A Look At Hung Chou Fiber Ind's Liabilities

According to the last reported balance sheet, Hung Chou Fiber Ind had liabilities of NT$812.0m due within 12 months, and liabilities of NT$807.5m due beyond 12 months. Offsetting these obligations, it had cash of NT$72.5m as well as receivables valued at NT$106.4m due within 12 months. So its liabilities total NT$1.44b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's NT$1.13b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Hung Chou Fiber Ind'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.

Over 12 months, Hung Chou Fiber Ind made a loss at the EBIT level, and saw its revenue drop to NT$1.6b, which is a fall of 51%. To be frank that doesn't bode well.

Caveat Emptor

While Hung Chou Fiber Ind's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping NT$159m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NT$272m over the last twelve months. So suffice it to say we consider the stock to be 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Hung Chou Fiber Ind , 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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