Health Check: How Prudently Does New Palace International (TPE:8940) Use Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that New Palace International Co., Ltd. (TPE:8940) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for New Palace International

What Is New Palace International's Net Debt?

You can click the graphic below for the historical numbers, but it shows that New Palace International had NT$393.3m of debt in September 2020, down from NT$673.3m, one year before. However, it does have NT$259.5m in cash offsetting this, leading to net debt of about NT$133.8m.

How Healthy Is New Palace International's Balance Sheet?

We can see from the most recent balance sheet that New Palace International had liabilities of NT$462.2m falling due within a year, and liabilities of NT$675.2m due beyond that. Offsetting these obligations, it had cash of NT$259.5m as well as receivables valued at NT$20.4m due within 12 months. So its liabilities total NT$857.5m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of NT$749.2m, we think shareholders really should watch New Palace International's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since New Palace International 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.

In the last year New Palace International had a loss before interest and tax, and actually shrunk its revenue by 33%, to NT$1.0b. To be frank that doesn't bode well.

Caveat Emptor

While New Palace International's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable NT$103m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of NT$78m. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for New Palace International you should be aware of, and 1 of them is potentially serious.

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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