These 4 Measures Indicate That Grand Pacific Petrochemical (TPE:1312) 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.' 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, Grand Pacific Petrochemical Corporation (TPE:1312) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Grand Pacific Petrochemical

What Is Grand Pacific Petrochemical's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Grand Pacific Petrochemical had debt of NT$640.6m, up from NT$59.8m in one year. But it also has NT$7.84b in cash to offset that, meaning it has NT$7.20b net cash.

How Healthy Is Grand Pacific Petrochemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Grand Pacific Petrochemical had liabilities of NT$2.48b due within 12 months and liabilities of NT$1.74b due beyond that. Offsetting these obligations, it had cash of NT$7.84b as well as receivables valued at NT$2.28b due within 12 months. So it can boast NT$5.90b more liquid assets than total liabilities.

This luscious liquidity implies that Grand Pacific Petrochemical's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Grand Pacific Petrochemical boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Grand Pacific Petrochemical if management cannot prevent a repeat of the 52% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Grand Pacific Petrochemical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Grand Pacific Petrochemical 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, Grand Pacific Petrochemical actually produced more free cash flow than EBIT over the last three 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 Grand Pacific Petrochemical has net cash of NT$7.20b, as well as more liquid assets than liabilities. The cherry on top was that in converted 167% of that EBIT to free cash flow, bringing in NT$2.0b. So we don't think Grand Pacific Petrochemical's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Grand Pacific Petrochemical's earnings per share history for free.

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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