These 4 Measures Indicate That Ocean Plastics (TPE:1321) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ocean Plastics Co., Ltd. (TPE:1321) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Ocean Plastics

How Much Debt Does Ocean Plastics Carry?

As you can see below, Ocean Plastics had NT$3.35b of debt at September 2020, down from NT$3.98b a year prior. However, it also had NT$755.7m in cash, and so its net debt is NT$2.60b.

A Look At Ocean Plastics' Liabilities

The latest balance sheet data shows that Ocean Plastics had liabilities of NT$1.01b due within a year, and liabilities of NT$4.65b falling due after that. Offsetting these obligations, it had cash of NT$755.7m as well as receivables valued at NT$717.1m due within 12 months. So its liabilities total NT$4.18b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Ocean Plastics is worth NT$7.51b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Ocean Plastics has a fairly concerning net debt to EBITDA ratio of 9.1 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Notably, Ocean Plastics made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$106m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Ocean Plastics'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Ocean Plastics actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Based on what we've seen Ocean Plastics is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the elements mentioned above, it seems to us that Ocean Plastics is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Ocean Plastics that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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