Here's Why President Chain Store (TPE:2912) Can Manage Its Debt Responsibly

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.' 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 President Chain Store Corporation (TPE:2912) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for President Chain Store

What Is President Chain Store's Debt?

As you can see below, at the end of December 2020, President Chain Store had NT$9.46b of debt, up from NT$6.74b a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$49.8b in cash, so it actually has NT$40.4b net cash.

A Look At President Chain Store's Liabilities

We can see from the most recent balance sheet that President Chain Store had liabilities of NT$82.7b falling due within a year, and liabilities of NT$81.8b due beyond that. Offsetting this, it had NT$49.8b in cash and NT$8.17b in receivables that were due within 12 months. So its liabilities total NT$106.5b more than the combination of its cash and short-term receivables.

President Chain Store has a very large market capitalization of NT$285.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, President Chain Store boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, President Chain Store saw its EBIT drop by 6.9% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if President Chain Store can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While President Chain Store 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, President Chain Store 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

Although President Chain Store's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of NT$40.4b. And it impressed us with free cash flow of NT$21b, being 141% of its EBIT. So we are not troubled with President Chain Store's debt use. 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. We've identified 1 warning sign with President Chain Store , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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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