CHANG TYPE Industrial (TPE:1541) Could Easily Take On More Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that CHANG TYPE Industrial Co., Ltd. (TPE:1541) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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.

View our latest analysis for CHANG TYPE Industrial

What Is CHANG TYPE Industrial's Debt?

The image below, which you can click on for greater detail, shows that CHANG TYPE Industrial had debt of NT$514.8m at the end of September 2020, a reduction from NT$661.3m over a year. However, because it has a cash reserve of NT$184.8m, its net debt is less, at about NT$330.0m.

How Healthy Is CHANG TYPE Industrial's Balance Sheet?

According to the last reported balance sheet, CHANG TYPE Industrial had liabilities of NT$1.82b due within 12 months, and liabilities of NT$292.6m due beyond 12 months. On the other hand, it had cash of NT$184.8m and NT$1.77b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$162.2m.

Of course, CHANG TYPE Industrial has a market capitalization of NT$4.09b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

CHANG TYPE Industrial's net debt is only 0.52 times its EBITDA. And its EBIT covers its interest expense a whopping 59.7 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Better yet, CHANG TYPE Industrial grew its EBIT by 108% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since CHANG TYPE Industrial will need earnings to service that debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, CHANG TYPE Industrial recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Happily, CHANG TYPE Industrial's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Zooming out, CHANG TYPE Industrial seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for CHANG TYPE Industrial you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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