Is President Chain Store (TPE:2912) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, President Chain Store Corporation (TPE:2912) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for President Chain Store

How Much Debt Does President Chain Store Carry?

The image below, which you can click on for greater detail, shows that at September 2020 President Chain Store had debt of NT$10.00b, up from NT$6.78b in one year. But on the other hand it also has NT$49.4b in cash, leading to a NT$39.4b net cash position.

How Strong Is President Chain Store's Balance Sheet?

The latest balance sheet data shows that President Chain Store had liabilities of NT$82.1b due within a year, and liabilities of NT$76.2b falling due after that. On the other hand, it had cash of NT$49.4b and NT$8.25b worth of receivables due within a year. So its liabilities total NT$100.6b more than the combination of its cash and short-term receivables.

President Chain Store has a market capitalization of NT$278.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, President Chain Store also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, President Chain Store saw its EBIT drop by 4.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine President Chain Store's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. President Chain Store may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, President Chain Store actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

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$39.4b. The cherry on top was that in converted 157% of that EBIT to free cash flow, bringing in NT$16b. So we don't have any problem with President Chain Store's use of debt. 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. Consider risks, for instance. Every company has them, and we've spotted 1 warning sign for President Chain Store you should know about.

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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