We Think Charoen Pokphand Enterprise(Taiwan) (TPE:1215) Can Stay On Top Of Its 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.' 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. Importantly, Charoen Pokphand Enterprise(Taiwan) Co., Ltd. (TPE:1215) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Charoen Pokphand Enterprise(Taiwan)

What Is Charoen Pokphand Enterprise(Taiwan)'s Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Charoen Pokphand Enterprise(Taiwan) had debt of NT$7.99b, up from NT$7.01b in one year. However, because it has a cash reserve of NT$247.7m, its net debt is less, at about NT$7.74b.

How Healthy Is Charoen Pokphand Enterprise(Taiwan)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Charoen Pokphand Enterprise(Taiwan) had liabilities of NT$5.84b due within 12 months and liabilities of NT$4.97b due beyond that. On the other hand, it had cash of NT$247.7m and NT$2.20b worth of receivables due within a year. So its liabilities total NT$8.37b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Charoen Pokphand Enterprise(Taiwan) has a market capitalization of NT$20.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Charoen Pokphand Enterprise(Taiwan) has a debt to EBITDA ratio of 2.9, which signals significant debt, but is still pretty reasonable for most types of business. But its EBIT was about 25.1 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. We note that Charoen Pokphand Enterprise(Taiwan) grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Charoen Pokphand Enterprise(Taiwan)'s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Charoen Pokphand Enterprise(Taiwan) burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Charoen Pokphand Enterprise(Taiwan) is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. Looking at all this data makes us feel a little cautious about Charoen Pokphand Enterprise(Taiwan)'s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Charoen Pokphand Enterprise(Taiwan) you should know about.

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. 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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