Is Chateau International Development (TPE:2722) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Chateau International Development Co., Ltd. (TPE:2722) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Chateau International Development

How Much Debt Does Chateau International Development Carry?

As you can see below, Chateau International Development had NT$306.6m of debt at December 2020, down from NT$376.7m a year prior. But on the other hand it also has NT$339.9m in cash, leading to a NT$33.3m net cash position.

How Healthy Is Chateau International Development's Balance Sheet?

The latest balance sheet data shows that Chateau International Development had liabilities of NT$413.8m due within a year, and liabilities of NT$184.2m falling due after that. Offsetting these obligations, it had cash of NT$339.9m as well as receivables valued at NT$13.9m due within 12 months. So its liabilities total NT$244.1m more than the combination of its cash and short-term receivables.

Of course, Chateau International Development has a market capitalization of NT$3.32b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Chateau International Development also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Chateau International Development grew its EBIT by 171% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Chateau International Development's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. Chateau International Development 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. Happily for any shareholders, Chateau International Development actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Chateau International Development's liabilities, but we can be reassured by the fact it has has net cash of NT$33.3m. The cherry on top was that in converted 276% of that EBIT to free cash flow, bringing in NT$185m. So is Chateau International Development's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Chateau International Development that you should be aware of before investing here.

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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