These 4 Measures Indicate That HsinLi Chemical Industrial (GTSM:4303) Is Using Debt Reasonably Well

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 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. As with many other companies HsinLi Chemical Industrial Corp. (GTSM:4303) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 HsinLi Chemical Industrial

What Is HsinLi Chemical Industrial's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 HsinLi Chemical Industrial had NT$197.0m of debt, an increase on NT$136.0m, over one year. But it also has NT$395.9m in cash to offset that, meaning it has NT$198.9m net cash.

A Look At HsinLi Chemical Industrial's Liabilities

Zooming in on the latest balance sheet data, we can see that HsinLi Chemical Industrial had liabilities of NT$239.5m due within 12 months and liabilities of NT$48.7m due beyond that. Offsetting these obligations, it had cash of NT$395.9m as well as receivables valued at NT$50.1m due within 12 months. So it can boast NT$157.8m more liquid assets than total liabilities.

This short term liquidity is a sign that HsinLi Chemical Industrial could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that HsinLi Chemical Industrial has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact HsinLi Chemical Industrial's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is HsinLi Chemical Industrial's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. HsinLi Chemical Industrial 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, HsinLi Chemical Industrial actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that HsinLi Chemical Industrial has net cash of NT$198.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$31m, being 210% of its EBIT. So we are not troubled with HsinLi Chemical Industrial's debt use. 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. For example, we've discovered 3 warning signs for HsinLi Chemical Industrial (1 is concerning!) that you should be aware of before investing here.

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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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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