Pou Chen (TWSE:9904) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Pou Chen Corporation (TWSE:9904) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pou Chen

What Is Pou Chen's Debt?

You can click the graphic below for the historical numbers, but it shows that Pou Chen had NT$69.8b of debt in June 2024, down from NT$75.7b, one year before. However, it does have NT$73.5b in cash offsetting this, leading to net cash of NT$3.69b.

How Healthy Is Pou Chen's Balance Sheet?

We can see from the most recent balance sheet that Pou Chen had liabilities of NT$81.9b falling due within a year, and liabilities of NT$46.4b due beyond that. Offsetting these obligations, it had cash of NT$73.5b as well as receivables valued at NT$40.2b due within 12 months. So it has liabilities totalling NT$14.6b more than its cash and near-term receivables, combined.

Of course, Pou Chen has a market capitalization of NT$121.3b, 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. While it does have liabilities worth noting, Pou Chen also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Pou Chen has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pou Chen can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Pou Chen has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Pou Chen actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Pou Chen does have more liabilities than liquid assets, it also has net cash of NT$3.69b. The cherry on top was that in converted 186% of that EBIT to free cash flow, bringing in NT$15b. So is Pou Chen's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 1 warning sign we've spotted with Pou Chen .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.