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

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Hung Chou Fiber Ind. Co., Ltd (TPE:1413) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hung Chou Fiber Ind

What Is Hung Chou Fiber Ind's 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. On the flip side, it has NT$72.5m in cash 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 this, it had NT$72.5m in cash and NT$106.4m in receivables that were due within 12 months. So its liabilities total NT$1.44b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$1.07b, we think shareholders really should watch Hung Chou Fiber Ind's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hung Chou Fiber Ind will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Hung Chou Fiber Ind had a loss before interest and tax, and actually shrunk its revenue by 51%, to NT$1.6b. That makes us nervous, to say the least.

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. Indeed, it lost a very considerable NT$159m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through NT$272m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Be aware that Hung Chou Fiber Ind is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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