Here's Why Taiwan Hopax Chems.Mfg.Co.Ltd (GTSM:6509) Can Manage Its Debt Responsibly

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.' 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. Importantly, Taiwan Hopax Chems.Mfg.Co.,Ltd. (GTSM:6509) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Taiwan Hopax Chems.Mfg.Co.Ltd

What Is Taiwan Hopax Chems.Mfg.Co.Ltd's Debt?

As you can see below, Taiwan Hopax Chems.Mfg.Co.Ltd had NT$1.85b of debt at September 2020, down from NT$1.98b a year prior. However, it does have NT$518.3m in cash offsetting this, leading to net debt of about NT$1.33b.

A Look At Taiwan Hopax Chems.Mfg.Co.Ltd's Liabilities

The latest balance sheet data shows that Taiwan Hopax Chems.Mfg.Co.Ltd had liabilities of NT$2.09b due within a year, and liabilities of NT$709.7m falling due after that. Offsetting these obligations, it had cash of NT$518.3m as well as receivables valued at NT$1.07b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$1.21b.

While this might seem like a lot, it is not so bad since Taiwan Hopax Chems.Mfg.Co.Ltd has a market capitalization of NT$4.74b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Taiwan Hopax Chems.Mfg.Co.Ltd's moderate net debt to EBITDA ratio ( being 2.2), indicates prudence when it comes to debt. And its commanding EBIT of 25.4 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Taiwan Hopax Chems.Mfg.Co.Ltd grew its EBIT by 44% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Taiwan Hopax Chems.Mfg.Co.Ltd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Taiwan Hopax Chems.Mfg.Co.Ltd's free cash flow amounted to 28% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Taiwan Hopax Chems.Mfg.Co.Ltd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. All these things considered, it appears that Taiwan Hopax Chems.Mfg.Co.Ltd can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. For example - Taiwan Hopax Chems.Mfg.Co.Ltd has 2 warning signs we think you should be aware of.

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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