We Think Alexander Marine (TPE:8478) Is Taking Some Risk With Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Alexander Marine Co., Ltd. (TPE:8478) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Alexander Marine

What Is Alexander Marine's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Alexander Marine had debt of NT$3.36b, up from NT$2.57b in one year. However, it does have NT$241.6m in cash offsetting this, leading to net debt of about NT$3.12b.

How Strong Is Alexander Marine's Balance Sheet?

We can see from the most recent balance sheet that Alexander Marine had liabilities of NT$2.83b falling due within a year, and liabilities of NT$1.49b due beyond that. Offsetting these obligations, it had cash of NT$241.6m as well as receivables valued at NT$1.36b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.72b.

While this might seem like a lot, it is not so bad since Alexander Marine has a market capitalization of NT$5.21b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

With a net debt to EBITDA ratio of 10.4, it's fair to say Alexander Marine does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 3.5 times, suggesting it can responsibly service its obligations. Looking on the bright side, Alexander Marine boosted its EBIT by a silky 75% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Alexander Marine 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Alexander Marine burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Alexander Marine's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Alexander Marine stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Alexander Marine is showing 3 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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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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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