Does San Fang Chemical Industry (TPE:1307) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that San Fang Chemical Industry Co., Ltd. (TPE:1307) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for San Fang Chemical Industry

How Much Debt Does San Fang Chemical Industry Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 San Fang Chemical Industry had NT$4.88b of debt, an increase on NT$4.13b, over one year. However, its balance sheet shows it holds NT$5.92b in cash, so it actually has NT$1.04b net cash.

A Look At San Fang Chemical Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that San Fang Chemical Industry had liabilities of NT$4.25b due within 12 months and liabilities of NT$3.22b due beyond that. On the other hand, it had cash of NT$5.92b and NT$1.26b worth of receivables due within a year. So it has liabilities totalling NT$300.5m more than its cash and near-term receivables, combined.

Of course, San Fang Chemical Industry has a market capitalization of NT$7.94b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, San Fang Chemical Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that San Fang Chemical Industry has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is San Fang Chemical Industry'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. San Fang Chemical Industry 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. Over the most recent three years, San Fang Chemical Industry recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that San Fang Chemical Industry has NT$1.04b in net cash. So we don't have any problem with San Fang Chemical Industry's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for San Fang Chemical Industry (of which 1 is concerning!) you should know about.

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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