These 4 Measures Indicate That CHANG TYPE Industrial (TPE:1541) Is Using Debt Safely

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. As with many other companies CHANG TYPE Industrial Co., Ltd. (TPE:1541) makes use of debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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

How Much Debt Does CHANG TYPE Industrial Carry?

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, it does have NT$184.8m in cash offsetting this, leading to net debt of about NT$330.0m.

A Look At CHANG TYPE Industrial's Liabilities

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. Offsetting these obligations, it had cash of NT$184.8m as well as receivables valued at NT$1.77b due within 12 months. So its liabilities total NT$162.2m more than the combination of its cash and short-term receivables.

Of course, CHANG TYPE Industrial has a market capitalization of NT$4.22b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

CHANG TYPE Industrial's net debt is only 0.52 times its EBITDA. And its EBIT easily covers its interest expense, being 59.7 times the size. 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. That boost will make it even easier to pay down debt going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual 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 free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, CHANG TYPE Industrial's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! 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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with CHANG TYPE Industrial .

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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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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