Is Chang-Ho Fibre (TPE:1468) Using Too Much Debt?

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. As with many other companies Chang-Ho Fibre Corporation (TPE:1468) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Chang-Ho Fibre

How Much Debt Does Chang-Ho Fibre Carry?

As you can see below, Chang-Ho Fibre had NT$973.5m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of NT$501.0m, its net debt is less, at about NT$472.5m.

How Strong Is Chang-Ho Fibre's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chang-Ho Fibre had liabilities of NT$737.3m due within 12 months and liabilities of NT$675.6m due beyond that. Offsetting these obligations, it had cash of NT$501.0m as well as receivables valued at NT$52.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$859.5m.

While this might seem like a lot, it is not so bad since Chang-Ho Fibre has a market capitalization of NT$2.38b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chang-Ho Fibre 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.

Over 12 months, Chang-Ho Fibre made a loss at the EBIT level, and saw its revenue drop to NT$965m, which is a fall of 3.5%. We would much prefer see growth.

Caveat Emptor

Importantly, Chang-Ho Fibre had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost NT$70m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of NT$15m and the profit of NT$48m. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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. Be aware that Chang-Ho Fibre is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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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